Photo (cc) by stevendepolo
Here’s a reader question that applies to lots of us, including yours truly:
I have a question. How does one budget, save, get out of debt, have money for quarterly taxes, etc., on an erratic income? I am an independent contractor and sometimes clients pay, and sometimes they take a long time to do so. I don’t like to push for payments because I am afraid work will dry up. Do you have any suggestions? Thank you very much.
Every year about this time we publish articles like Resolve to Budget in 2016: Here’s How to Do It Painlessly, explaining how to create a spending plan — something essential to accomplishing your financial goals.
A spending plan, otherwise known as a budget, is about tracking your income and expenses so you can find the money to achieve your goals. But a spending plan has three necessary ingredients: a goal, an estimate of expenses and an estimate of income. If you can’t estimate your income, you can’t plan.
There are a lot of people in this position, from commissioned salespeople to the self-employed. I’m one of them. The last time I received a regular salary was April 1981.
How to budget with a variable income
When it comes to planning around a variable income, there’s no simple technique allowing you to accurately predict the unpredictable. And the more your income varies, the harder it is. If your income fluctuates by 10 to 20 percent, no big deal. More problematic is income that fluctuates a lot. In 2009, my income plunged 90 percent from what it was in 2008, and I didn’t see it coming. In 2014, I made twice as much as I did the year before, and, again, it was a surprise.
So what are those of us with wildly fluctuating incomes to do? The best we can. Here are the steps to take:
Step 1: Create a spending plan
Start your budget with what you can estimate: your expenses. Create your plan and automatically track your expenses with a free online budgeting tool like PowerWallet, the service I use. Open a free account, provide your checking account information, and the site automatically tracks money spent and assigns it to the categories you’ve established. There you have it — instant expense tracking. The only thing you’ll need to manually input is cash expenses.
So if you haven’t tried an expense tracking service like PowerWallet or Mint, do it. They require less effort than software, or manually entering expenses into a budgeting spreadsheet. And that’s important, because the more automatic you make budgeting, the easier it is to stick with.
Step 2: Estimate your income
As I said above, there’s no magic bullet. If you expect your annual earnings to come close to what you earned last year, simply divide last year’s income by 12 and you’ve got your monthly income. If you realistically expect it to be higher or lower, adjust that number accordingly. But if you have no idea what your income might be, that’s not an excuse to stand like a deer in headlights and do nothing. You’re better off with a lousy estimate than none.
Keep in mind that when estimating either expenses or income, you’re allowed to be wrong. It’s OK to make adjustments — that’s normal. A budget isn’t a diet — it’s not about deprivation, or right and wrong. It’s about choosing how to allocate your resources in accordance with your wishes. Whether it’s income or expenses, get started, then make adjustments as you go.
Step 3: Make your variable income fixed
Want a regular salary so you can plan better? Give yourself one.
Open two bank accounts: a checking account and a savings account. Every time you receive money, deposit it into your savings account. Then, every two weeks (or every week or month — whatever you like) transfer the amount you estimated above into your checking account and use it to pay your expenses and fund your goal.
When you have “fat” months, you’ll build savings. When times are lean, you’ll draw from savings to keep your “salary” intact.
If you have a big savings balance at the end of the year, divide it by 12 and give yourself a monthly raise. If you don’t have enough in savings to make it work, you’ll have to take a pay cut and take a hard look at your expenses so you can stay on track to meet your goals.
It may take time to discover your correct “salary,” and if your income fluctuates as wildly as mine, you may never find it. That’s OK. This is about progress, not perfection. The simple fact that you’re looking at your expenses and striving for a goal is going to radically increase your odds of success and your control over your money.
How to push your clients for payment
In addition to an irregular income, Zena also has a problem with getting clients to pay without being pushy. She says, “[S]ometimes clients pay, and sometimes they take a long time to do so. I don’t like to push for payments because I am afraid work will dry up.”
There’s a simple solution for late payers: Make it profitable for them to pay promptly. Ever heard of “2/10, net 30?” It allows a client to take a 2 percent discount providing they pay within 10 days, and full payment is due within 30.
I don’t know if this will work for Zena, but if she’s willing to take a small haircut to get paid faster, she should put this policy on her invoices, then send a carefully worded email or letter to her clients. She’ll present it as a new benefit: “Good news! For my best clients, I’m now offering a discount of 2 percent for invoices paid within 10 days. Take advantage of it and save money!”
Will it work for everyone? Nope. But a carrot like this is a better way to approach clients than the “stick” of pushing for payment.
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I founded Money Talks News in 1991. I’ve earned a CPA (currently inactive), and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate. Got some time to kill? You can learn more about me here.