Contracting can be rewarding both financially and personally – but it does come with some challenges, one of which is living without guaranteed income. Our blog provides some easy budgeting tips that can help your cash flow.
If you already have a contract secured for the next six months to a year it is easier to work out what you’ll make versus bills, savings and living expenses. However, if you’re between roles or will be working on shorter contracts throughout the year, a good strategy is to assess what you must earn in order to live comfortably and then price out what you need to earn in the year to get there. It doesn’t have to be over a 12-month period, but whatever amount of time you feel makes sense.
Remember, as a contractor you choose what to charge for your own services, so you should consider both what you need to be earning versus what compensation you deserve for your skills. This will help you budget effectively by knowing what your gross income will be, and will give you a baseline for setting your rates in the future.
Many professionals choose to be contractors or freelancers due to increased earnings potential. However you may not receive the maximum income available to you if your payroll method isn’t right for you. Contractors don’t get paid via their client’s books, and agency PAYE is essentially the same as getting paid as a regular employee – with the same income tax and National Insurance deductions. That leaves 3 options: limited company, umbrella company or sole trader.
Working as a sole trader can yield high returns, but you would be personally liable for any financial losses of your business. The umbrella company route gives similar returns to permanent employment, however if your working practices meet certain conditions you may be able to claim some operating expenses. The limited company option, which provides limited liability for financial losses, can provide high returns if you have a tax planning strategy in place; this depends on your working practices and whether you are okay with some administrative burden.
The type of payroll service that will work for you depends on your work and the kind of life you’d like to live whilst contracting. Choosing the right payroll service will allow you to maximise your take home pay and help you budget for the lifestyle you wish to live. This take home pay calculator can give you an idea of your potential take home pay through these payroll options.
Whether you’re saving for a rainy day or for a new home, following the rule of putting 10-20% of your take home pay away as savings can help you reach your saving goals if you can manage it. However even if you are able to put money away every week or month, it can be easy to dip back into your savings whether it’s in an Instant ISA or a plastic bag under your mattress.
If locking your savings away so you have no access is not an option, then once you put your money away you should think of it as money you no longer have. This way you are less likely to dip into your savings.
As a contractor, putting money away for a rainy day is especially important when work is not guaranteed. Saving for a sick day or when you are in between contracts will ensure you aren’t left high and dry financially.
Whether you have your own limited company or work through an umbrella company, accounting software is one of the best ways to manage your finances as a contractor, so be sure to make full use of this tool available to you. Your contractor accountant would have provided you with a client portal for you to track your incoming funds and how much you need to keep aside for taxes (for limited company directors).
There are many other budgeting and saving tools out there that can give you a bit of extra help:
- You Need A Budget (YNAB): YNAB can be used on desktop or mobile and is a tool for those who are in need of a more strict budget regime. With the app, you import your bank files and then assign your funds to all the expenses you have and will have so that everything is strictly accounted for. The idea of assigning every pound to an expense means you spend smarter.
- Idealo: If you’re prone to impulse buying or online shopping, this free app will help you get items for cheaper elsewhere. Idealo can compare prices when you search via the app or scan a product’s barcode. If you know you can buy the item for cheaper elsewhere, you’ll save money and you may even be less likely to buy impulsively, as you are putting more thought into the transaction.
- Pennies: Pennies is an app that uses your local currency to monitor your spending, and gives you a daily spending allowance. Whether you go over or under your daily budget, the app will adjust to show you what you can spend the next day based on this. This helps you to limit impulse purchases.
If you have a business account and a personal account, it’s important to keep expenses from these accounts separate; don’t use your business account for personal expenses and vice versa. Not only could this create unnecessary tax implications, such as not being able to claim an expense against your Corporation Tax bill, but you could also accidentally give yourself a director’s loan, which is an expense from a limited company’s bank account which is not a salary, dividend or expense repayment and must be paid back to the company. That’s why it’s important for your budget and cash flow to keep your accounts organised and separate.
These budgeting tips can help you be more aware of your expenditure and ensure you have enough to cover times when you are in between contracts, off sick or on holiday. Different budgeting tactics work for different individuals and you should choose a method that will work best for you. You should also discuss tax planning with your accountant who can help you maximise your take home pay.
Contact us if you have any questions on contractor accounting and accounting services.
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