If you’re an independent contractor, freelancer or gig worker, your income may not be as predictable as that of an employee with a regular paycheck. When your income varies from month to month, setting a budget is critical to meeting your financial goals.
Add up your fixed expenses
Start by determining your fixed monthly costs, which are the ones that vary little, if at all, from month to month. These might include rent or mortgage payments, utilities, internet service, or car payments.
Add up these expenses by reviewing your bank and credit card statements from the past three to six months, then determine a monthly average.
Also include annual expenses, such as property taxes, homeowners’ insurance premiums, car registration, and holiday or birthday gifts. Add up these expenses and divide the total by 12 to estimate how much you should put aside monthly to pay for them.
Listing the dates when recurring expenses are due helps you manage your income so you can pay your bills on time.
Estimate your variable expenses
Unlike fixed expenses, variable expenses can change drastically from month to month. In general, variable expenses are discretionary purchases—nice to have, but not essential. For example, groceries are essential, while restaurant meals are discretionary. Variable discretionary expenses can also include clothing, travel, and movie tickets.
Calculate your average income
Next, get a general idea of how much money you make every month. To do this, add up your gross earnings from at least the past three to six months, and divide the total by the number of months to arrive at an average monthly income. For example, if you earned $3,000 one month, $2,100 the next and $2,800 the third, your total is $7,900 and your monthly average gross income is $2,633.
Once you’ve estimated your gross income, you’ll need to subtract taxes to arrive at your net income. Unlike employees who have income tax withheld from their paychecks, independent contractors must pay both self-employment taxes and regular income taxes out of their paychecks.
Allocate your paychecks
Now that you have an idea of your income and expenses, allocate where your income goes by making a budget. There are several ways to do this, but zero-based budgeting may work well for many independent contractors.
With a zero-based budget, every dollar you earn is assigned to a specific expense so that your income and expenses “zero out.” Be sure to include all the categories you created when assessing fixed and variable expenses.
Build an emergency fund
As an independent contractor, you may not always qualify for unemployment benefits if your work dries up or your biggest client goes out of business. You must be prepared to provide your own safety net, which is why a solid emergency fund is essential. Aim to build an emergency fund that can cover three to six months’ worth of essential expenses. If your income is extremely irregular, or you’re in an industry with frequent economic ups and downs, you may want an emergency fund sufficient for 12 months of expenses.
Adjust your budget as you go
Your first attempt at budgeting with irregular income will undoubtedly need some fine-tuning. At the end of each month, review whether your budget met your financial needs. Did you overspend? Did you save enough? Tracking your expenses will help you figure out where to adjust your budget.
For more information on budgeting, see the following articles: