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This post is more important for the self-employed consultants among you, as I’m going to talk about finance of the business. If you are starting as a self-employed consultant or you wish to become one, this information will be very relevant for you.
Income
This is quite straight forward, you work for clients, generate invoices, and they pay you. However, the main question is: when will they pay? Usually it’s not immediately, the payment is delayed. By how much? That depends on your contract. In Canada, payment is usually pretty fast and is done without many issues, so at the end of the month you generate the invoice and usually within the month you get the money. In Israel it takes much longer. Usually companies pay in the following month of the invoice or even 2 months after (if the invoice was generated at the beginning of February for work performed in January, the payment will be made in March or even April). Also, don’t forget that some companies are not organized and might not pay in time and you’ll need to remind them, making the payment come even later.
So remember, you might work in the beginning of January and get the payment in March or even later. You need to plan your finances and cash flow accordingly.
Business Expenses
Expenses can be a benefit for the self-employed. Check with your accountant what can be considered as an expense and use it to reduce taxable revenue/income. That way you can buy things you use without paying taxes as they are used for your work. Cell phones and the cell bills are part of it, travel expenses (when you travel to clients or conferences), relevant courses and software, any physical equipment for your work (laptop, microphone, webcam, desk, and more), and if you have a home office, then maybe even some of your rent might be eligible.
Cash-Flow
As income and expenses are easy to understand, people sometimes overlook “cash-flow”. If you don’t know the term, this is the real movement of money in and out of your bank account. The fact that you worked for a client and they owe you money, doesn’t mean you have this money available to go and buy groceries. You will need to receive the money first. So “on paper” you have the money, but in reality, you still don’t.
As a self-employed consultant you should be aware of this, especially when you are starting out. You have just quit your job and you are starting as a self-employed consultant. Even if you have clients from day one, you may only see the payment in 2-3 months (unlike an employee who will get their salary at the first payment day (be it the middle of the month, the end of the month, or anything else, depends on the country). You need to plan for this and have enough funds to support you during this time. Also, remember that clients come and go and sometimes you’ll have fewer clients and less income, so be prepared for this from a cash flow perspective, save funds during the good times for the more difficult times and work hard whenever you can.
Another cash-flow issue that self-employed people have and employees don’t is time off. Whether it’s vacation, sick days, or just work that you don’t get paid for (such as conferences, see my post about becoming an independent consultant). Similar to the delay in receiving the payment after performing the work, the negative effect of lack of work will be apparent some time after missing working days. Be aware of this and plan accordingly.
One last thing about this, if at some point you consider using subcontractors yourself, make the payment terms with them similar or longer than the ones you have with the client. Make sure you don’t need to pay them before you get the money, as this may cause a huge cash-flow problem for you.
Taxes
As employees, we get a paycheque every month and the company’s accountant makes sure to take taxes off of our payment. As a self-employed person, this doesn’t happen. The client pays us the full amount (for our work plus any relevant taxes like VAT) and we are responsible to pay the taxes (the VAT we collect and our income tax). Note that as a self-employed consultant you don’t get a paycheque, meaning nobody else knows how much you made each month. It is your responsibility to report it accurately and pay the taxes (the process depends on each country so check how it works).
In my case the tax filing is annual at the beginning of the following year. This means that I get to keep the money throughout the year and I pay the taxes at the beginning of the following year. While this is great and I have more money to “play with” during the year, at the beginning of the next year there is a year-worth tax bill I have to pay. This also relates to cash-flow from the previous part. When you get the tax bill, you have to have enough money available (cash in the bank, not only revenue/profits on paper) to pay it. So make sure you save enough money for that on a regular basis (ideally put aside a certain percentage of your income each month based on your estimated annual taxes to save for the annual tax payment).
Installments
At some point, some countries (Canada and Israel included) might ask you for installments. These are tax pre-payments. This did not happen for me in the first year here in Canada (as this is based on previous year’s income, this makes sense), but on the 2nd or 3rd year I got a letter asking for installments.
Basically, they take your previous year(s) tax and request this money during the year in a few payments instead of a single payment at the beginning of the following year. You might find this more convenient cash-flow wise (since it’s divided into several smaller payments), but even if you don’t, you usually don’t have a choice. Talk to your accountant, understand how it works and prepare for it, so you’ll have enough money to pay the installments as well as your regular day-to-day expenses.
Investing in the Business
Now that you’re managing your cash-flow and putting money aside for taxes, what should you do with extra money that you’ve got? The first thing to do is to invest in yourself and your business. You are the most important asset, so don’t be afraid to invest in courses, professional development, relevant software, coaching or other services, etc.
Next can be upgrading some equipment if you need to (like buying a new chair, desk, speakers, earphones, laptop, monitors, whatever) or you can go for paid services for your brand (pay for logo, website designer, hosting, etc.). Use this money wisely to promote yourself and build a better work environment.
Remember, all of these are business expenses so they are deductible when preparing your taxes, which is great.
Investing Your Extra Money
After everything I mentioned above, what should you do with the extra cash? This is crossing over from business finance into personal finance and different people have different approaches. However, remember that your “job” (or income) can be more secure in some ways than a salaried employee, and less secure in others. On the one hand, you can hustle more to find new clients or work extra-long hours, rather than be dependent on a single source of income from which you can be fired at any moment; but on the other, you have less month to month stability of income and need to remember your annual tax bill and other potential expenses (extended sick leave for example).
After basic needs are taken care of (shelter, food, health, transportation), some people like to buy cars, travel or otherwise spend the money. While I think some of this is important (and some is fun), it’s also important to save for the future. I think the COVID-19 era showed us how important this is, both for salaried employees and for self-employed people. Things might not be as stable as we think and you don’t want to find yourself without any income. Spend some of the money and keep the rest (and some people even say: save money first off the top to “pay your future self”, and then you can spend the rest in the present). Save it for a longer term so you can be protected should something happen.
I’m not going to get into personal finance, saving, and investing here, as this is a huge topic and I’m far from being an expert. There are books, blogs and other info about that, so learn and decide how to manage your money so it will work for you. I will say however, that there are many options to save and invest, and many options to optimize taxes. Think about the long run, all the way to retirement, use the tax benefits (like tax free investment options and tax free options for retirement) so you can maximize your investment and plan your financial future.
Do you have any thoughts or feedback about this topic? Leave them in the comments below.
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Excellent post