Budgeting on an irregular income: A guide for sole-trader contractors and freelancers

Budgeting can be hard enough for those in regular employment, who need to cover today’s bills as well as, hopefully, tomorrow’s emergency savings and investment in their future. But if you’re a self-employed sole trader, you have three more financial headaches to add to the list: setting aside correct amounts to pay the ATO, covering your own super contributions, and dealing with periods when there is no income flowing in. It can seem like a formidable task, but with the right advice, you can create a budget that will help you to navigate this potential minefield.

Here’s the solution, step-by-step.

1. Structure your budget around your minimum reliable income

If contracting or freelancing is your sole income source, what is the lowest amount you can reasonably expect to earn in a year? Base your budget income on this, not on your highest expectations. Then, set your monthly household spending target to a figure close to your lowest expected monthly income, and direct any surplus income in the better months towards savings and investment.

2. Separate business and personal finances

You will need separate bank transaction accounts for your business and household income and expenses. Your household income will be a regular ‘salary’ you pay yourself from your business account. If necessary, create two budgets – household and business – and maintain a separate bank account for amounts you will set aside to pay your income tax and superannuation (see below).

3. Budget for unpaid working time

Employees get paid for public holidays, sick days and annual leave, but as a self-employed person, you do not. You also need to allow unpaid time for administration, bookkeeping, marketing and professional development. It’s important to recognise that you may only be able to bill clients for 25-30 hours per week, even though you are working full-time.

4. Expect slow-paying clients

Your budget should assume that not all your client invoices will be paid on time. As well, your income may vary seasonally, and some promised work may be cancelled. Try to avoid the mistake of committing to expenses based on invoices you have issued, but for which you have not yet received the cash.

5. Treat tax as an unavoidable expense, not an afterthought

Employees can rely on their employer to make PAYG deductions before they receive their salary, but the self-employed cannot. They need to avoid the temptation of regarding all cash received as their business income. Some of it will be GST (if you’re registered) and some of it will be needed for income tax (PAYG instalments), both usually payable quarterly to the ATO when you lodge your Business Activity Statement (BAS).

Ideally, set aside 25-30% of your gross revenue for the purpose of paying income tax. Add an additional 10% if your revenue includes GST, and ideally an additional 12% for your own super contributions.  

6. Plan for superannuation

Sole traders are not legally required to pay super contributions for themselves, but it’s a good idea to do so to provide for your retirement in a tax-concessional environment. You may be able to claim a tax deduction for your personal super contributions. Your financial adviser can help you set up your contributions into an external or self-managed fund and discuss the pros and cons of claiming them as a tax deduction.

7. Level out irregular expenses

Many expenses occur quarterly or annually rather than weekly or monthly. This includes personal expenses such as life insurance, car registration and rates, and business expenses such as professional indemnity insurance, accounting fees, software subscriptions, and equipment replacement. Where possible, take advantage of monthly payment plans if you can do so without a financial penalty. Otherwise, add up these bills, divide by 12, and set aside this amount each month.

8. Consider fixed expenses cautiously before committing

Large, fixed expenses, such as a mortgage, vehicle finance or an equipment lease, can put pressure on you if your income falls short of expectations. Think carefully about how you would manage in slow- income months.

9. Create a cash buffer

Aim to build a cash reserve that’s capable of covering both your household and business expenses for 3-6 months in an emergency. This will provide flexibility if you lose a major client, or payments are delayed, or you become temporarily unable to work.

10. Work with a financial adviser

Sole traders face many financial pressures, and these can become a major distraction that prevents them from concentrating on their business. But the burden can be considerably relieved by enlisting the services of a financial adviser to steer them through the intricacies of creating and maintaining an effective budget that will provide for their current needs and future security.

The information provided in this article is general in nature only and does not constitute personal financial advice.