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One of the biggest worries a lot of people have about starting a business is having to budget on an irregular income.
Gone is the security of a regular paycheck, where you know exactly when and how much you’re going to get paid every month.
But, in its place is the possibility of earning a much larger income…
When you’re your own boss, you don’t have to…
- Psych yourself up to ask for a raise
- Worry that your job is going to be taken away from you without warning
- Or set a cap on your earnings
That being said, surviving on an irregular income can be tricky. You need to make sure that you have money in your account to pay your bills when they fall due.
On the blog today, R.J. Weiss from The Ways to Wealth is going to share his best tips for budgeting on an irregular income so you don’t have to panic about having enough money in your account to pay your bills and can enjoy the freedom that being your own boss can bring!
Take it away, RJ!
How to Budget When You Have an Irregular Income
The hardest transition I went through with my finances was going from the steady salary of a financial professional to the irregular income of a blogger.
A steady income can make life easy. When you have one, you know exactly how much you can spend each month. You can invest on autopilot. And you can set up auto-payment on your bills, knowing the money will be in your account on the due date.
That all disappears the moment you switch from a salary to an irregular income.
More workers today are moving towards an irregular income. Side hustling, freelancing, working on commission, and owning a business — these are growing trends. And these career options don’t come with a typical steady paycheck.
One common mistake made by people with irregular income is having a “that’s not for me” attitude when it comes to basic financial advice.
And that’s a problem because things like living on a budget, paying your credit card payment in full each month, saving money for your future, and having a retirement plan are the fundamentals of personal finance and prerequisites for building wealth.
While having an irregular income can make managing your day-to-day finances more difficult, it doesn’t change the fact that you need to manage them.
This article outlines a three-step process for living month-to-month on an irregular income. This is the process that worked for me and my family (after a little bit of trial and error…).
Step #1: Decide On Your Monthly Budget
Financial habits are hard to break. Especially after living on a steady paycheck for ten years. At least that’s what I found after I left my job to focus on my website, The Ways To Wealth, full-time.
One of the first questions I asked myself was, “OK. How much can I spend each month?”
The most popular theory I came across was to budget on the lowest monthly estimate for your prior twelve months. So, if the range of monthly income you experienced over the previous year was $2,000 to $6,000, you would create a budget based on the $2,000 figure.
This makes sense for people who have a somewhat stable twelve-month earning history; if you’ve been at the same job for twelve months and worked on a commission, for example. But it can leave a lot of questions for others. What if you took a two-week unpaid vacation, which resulted in earning about 25% of your average monthly income? Should that be the month you base your entire budget off of?
In my case, I had only started earning real money from my fledgling business six months before transitioning to it full-time. So that number would have been zero.
So I decided to work out a formula for myself: I would create a budget based on 80% of my six-month average. For example, if my average income over the last six months was $5,000, I’d budget based on $4,000 of income.
This formula isn’t perfect. For example, it wouldn’t work for seasonal workers who earn 80% of their income in a three-month span.
The inconvenient truth is that there’s no perfect formula. What works best is making continuous adjustments and improvements to your system.
What works for you may be a six, nine, or twelve-month average. Or maybe it’s budgeting based on your lowest monthly earnings for the year.
Assess your situation and choose something that works for you. Like many things, it may take some trial and error, but it’s time well spent.
Step #2: Determine What’s Essential vs. What’s Nice to Have
One benefit of an irregular income is that the reward for your work often comes much sooner. A salaried employee can put in twelve months of work before seeing a raise. Entrepreneurs and freelancers, on the other hand, can make money quickly.
This fact is incredibly motivating. And this motivation is something you want to take full advantage of. That’s why I’ve found it helpful to separate my expenses into “essentials” and “wants.”
The “essentials” are my month-to-month expenses — things like housing, food, transportation, insurance, education, utilities, taxes, and savings.
Then there are the “wants” — things like eating out, vacations, entertainment and — since I work from home — the nicest sweatpants I can afford.
These “wants” motivate me to continue to increase my income. So I put them in my budget.
I then like to think of my income as aiming to fill up two separate buckets.
Bucket #1 is the essentials. I have to fill that bucket up first. Once that’s complete, the overflow goes into Bucket #2.
Note: I’m still using six-month averages to determine the overflow. For example, earning $6,000 more this month would result in a $1,000 increase in the “wants” category for the current month. In other words, it’s not like I would immediately go out and spend that $6,000. Instead, it increases the overall average.
Keep in mind, the equation works both ways. If my six-month rolling average decreases, that reduces the amount that goes into “wants.”
As you’ll learn below, the key is to continuously make adjustments based on the best information you can get.
Step #3: Make Adjustments
Managing your personal finances is a skill. And just like other skills, it takes practice. And this practice is not always easy.
It’s for this reason that many people give up shortly after they set the goal to get their finances in order.
Bad things will happen. You’ll lose your biggest client. Your car will break down. You’ll have unexpected house repairs to take care of.
It’s in these pivotal moments that it’s important not to give up. Instead, you need to readjust.
Adjusting and learning from your mistakes are key aspects of surviving long-term on an irregular income.
And it’s not only about adjusting your numbers. It’s just as important to adjust your systems.
Maybe a six-month average doesn’t work for you. Try something else.
Maybe separating your expenses into wants and needs doesn’t work for you. In that case, try something else!
I like setting a calendar reminder to review both my personal and business finances once per month. During this time, I’m always asking myself what worked and what didn’t.
If you’re like me, you’ll make your fair share of mistakes. But these mistakes are opportunities to learn and readjust. And it’s in these mistakes that you’ll find a system that works for you.
What you’re getting when going from a steady to an irregular income is the upside. With an irregular income, you have more control over what you earn. And while it can make managing money month-to-month somewhat more complicated, finding a system that works for you can provide more opportunities throughout your career.
There you have it! Learning to budget on an irregular income doesn’t have to be a source of worry or overwhelm. If you put steps in place to manage your variable budget, you’ll feel a lot more confident every month and come tax time.
Haven’t even started your business yet? What’s stopping you?
Check out Work-At-Home School to learn how you can start your work-at-home journey!
R.J. Weiss is the founder and editor of The Ways To Wealth, a Certified Financial Planner, husband, and father of three. He’s spent the last 10+ years writing about personal finance and has been featured in Forbes, Bloomberg, MSN Money, and other publications.