Budgeting with a variable income: pay yourself a salary
Budgeting on a variable income is not about predicting next month. It is about no longer depending on being right.
In short
With a variable income the method is to pay yourself a salary: everything you are paid goes into an account you do not spend from, and once a month you transfer yourself the same fixed amount. Set it close to your worst month, not the average. Three things leave before the salary: tax, business costs and the emergency fund, which here is six months rather than three.
If you work for yourself, on commission, or run your own business, the standard advice does not apply: it is written for somebody who knows what lands on the 30th. The problem is not that you earn little; it is that you do not know when.
The method: pay yourself a salary
The idea is simple and it changes everything. Instead of spending what came in this month, everything you are paid goes into an account you do not spend from. Once a month you transfer yourself the same fixed amount: your salary.
That account is a buffer. Good months fill it, bad months drain it, and your life stops rising and falling with your invoicing.
What salary to set
Take the last twelve months of income, or however many you have. Do not use the average: use something close to your worst month, or the average minus twenty per cent.
Yes, it will be tight at first. That is the point: a salary that only works in good months forces you to cut back exactly when the bad month arrives, which is when cutting back is hardest.
Once the buffer reaches three months of expenses, raise it. Not before.
What comes out before the salary
Three things leave before anything reaches you:
- Tax. A fixed percentage into a separate account on the day you are paid. It is the quietest debt of self-employment: no bill arrives monthly, and then it all arrives at once.
- Business costs. Tools, software, transport, the part of your home you work from.
- The emergency fund, which in your case is six months, not three. You have no redundancy pay and no unemployment cover.
What is left after those three is where the salary comes from.
The irregularity buffer
This is a different thing from the emergency fund and you want both. The emergency fund is for the unexpected; this is for the expected whose date you do not know: the client who pays in sixty days, January, the project that slipped a month.
Three salaries in there and you stop taking bad work out of need. Over time that tends to raise your income more than anything else does.
Keep fixed costs low on purpose
On a variable income, every fixed payment you add raises the bar you have to clear each month. Subscriptions, instalments, memberships: each one cuts the number of bad months you can absorb.
Flexibility is the advantage that compensates for the uncertainty. Spending it on monthly commitments trades your only advantage for convenience.
Getting paid is part of budgeting
An invoice sent is not money. Keep a list of who owes you and since when, and chase it with the same discipline you record expenses with. Variable income becomes a lot less variable when people pay on time.
What to look at each month
Two numbers: what came in, and what you paid yourself. If the first is bigger several months running, raise your salary. If it is smaller, you knew in advance — and that is what the buffer was for.
Common questions
- How do I work out what to pay myself?
- Take whatever history you have and use the lowest month, or the average minus twenty per cent. Once the buffer reaches three months of expenses, raise the salary — not before.
- What is the difference between the emergency fund and the irregularity buffer?
- The emergency fund is for the unexpected. The buffer is for the expected without a date: the client who pays in sixty days, January, the project that slipped a month. You want both.
- Why keep fixed costs low?
- Because every monthly payment you add raises the bar you must clear and cuts the number of bad months you can absorb. Flexibility is the advantage that compensates for the uncertainty.
Try it on your own money
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