Elance Blog

Tips To Manage Your Finances As A Freelancer

Managing finances as a freelancer can be overwhelming, especially considering the fickle economic climate almost everyone in the world is facing today. Big financial commitments, like buying a home, purchasing a new car, or deciding to raise a child, requires a good amount of strategic financial planning. Shane Pearlman, founder of the popular Freelance Camp and partner at Shane & Peter Inc, lays out a mathematically sound plan that you should consider if big financial commitments are within your horizon.

Can You Afford To... Buy A Home / Car / Child?

I have until 3pm today to make a final decision on whether to buy a new house and turn my current one into a rental. Alternatively, I also have the option to use the cash to refinance my current home to lower my cost of living. It's a tough questions and I have been running the numbers and agonizing the choice for weeks.

Let me start by assuring you: if you take your freelance business seriously, learn how to sell, solve the right problems, understand your finances and hone your technical skills, odds are in your favor that you will far surpass any previous employment income. It took me three years of full time freelancing to hit that point. Ten years later, I would never consider going back. We have bought 3 homes and are putting profits from my business into rental properties (my retirement plan).

What makes big purchases such as a house challenging is that (as a freelancer) our income is somewhat unpredictable. The good news, smarter people than me have build formulas that let us make some very good guesses.

How Do You Measure Your Income?

How much profit will you take home in the next six months? Many freelancers I know freeze when asked that question. Since most of our work comes word of mouth and many times I write proposals that fizzle or come to nothing, I did not have the slightest idea how to answer the question when the loan officer asked me. That night at dinner, my family was in town visiting and my father laid out a formula. Before you go grab your Weegie board, get out a piece of paper.

Your income = Sum (Current Contracts) + Sum ( Value of Bid * Odds of Winning ) - Fixed expenses - Taxes

Let's break it down.

Count your current contracts from July 2009 - Dec 2009. As long as you deliver the work and your clients pay, this is money you can basically count on.

Name — Value — Start Date

Project 1 — $10,000 — July 2009
Project 2 — $3,500 — Aug 2009
Project 3 — $15,000 — Oct 2009
Total $28,500

Ok, now for the more interesting formula. I personally had a hard time believing it would work, but having used this for close to a decade, I continue to be astounded at its accuracy.

Name — Proposal — Odds — Value

Project A — $18,000 — 50% — $9,000
Project B — $4,000 — 80% — $3,200
Project C — $40,000 — 20% — $8,000
Total $ 20,200

Now lets sum it all up.

Current Contracts: $ 28,500
Sales Pipeline: $ 20,200
Total 6 Month Gross Income: $48,700
Projected Expenses: -$7,800
PreTax Net Income: $ 40,900
Withhold 35%* for taxes: -$14,315
Take Home Income: $26,585
Monthly Income: $4,430
* enter the tax for your state/country/tax bracket

Once you have the numbers to work with, then run through the following three questions:

What Can You Do?

Based upon the lending practices of your state / country, what type of loan does your income allow? In the USA, there is an unwritten rule of 1/3. No more than 1/3 of your family income may go to housing if you want to get a loan. That means in your monthly take home is $4,430 then you can afford a monthly house payment (loan + taxes + insurance) of $1477. Of course if you are married and your spouse work then that will be higher.

How much savings do you have? How much risk are you comfortable with? For example, my wife and I have a family rule that states we are not allowed to touch our 6 month reserve in order to buy anything material. It is for emergencies only. I have friends who feel the same way about a one year reserve while others who have a three month or just go on faith. Everyone is different, but you need to set your own baseline.

What Should You Do?

Just because you can, does not mean you should!

Julie and I have a long term financial plan for our family. It includes Serenity, our daughter, and the fact that Julie is now able to stay home full time for a year with her. It includes our retirement approach, which in our case is real estate as I truly enjoy hunting for houses. It includes travel (going to Australia on vacation this November to see Julie's sister), ongoing education, car replacement, how much we can eat out, how many surf board I get to buy. While we leave a lot of room for flexibility, I have a general sense of where we plan to go financially.

I measure every purchase against our family plan and ask: will this purchase take me closer of further from the long term future my wife and I are aiming for?

What Do You Want to Do?

Once the financials have been determined, we then take into account our feelings, preferences and desires. Sometimes, we take the second best financial choice because we will enjoy the outcome more.

Our pattern is to buy a place, live in it a few years while we build up savings, then rent the current one and buy a new one. This time, Julie wants to live in walking distance from the ocean. We are quite likely to choose a house that is slightly less ideal within the bounds of our investment portfolio in order to accomplish that goal. After all, happy wife = happy life. But without having answered the questions above, we wouldn't know where to draw the line.

And with that said, I need to go on a long walk with Julie so that we can make a final decision. Wish us luck.

About the Author:
Shane Pearlman has run a successful full-time freelance business for over ten years and is the founder of Freelance Camp, a series of bar camps taking place throughout the world supporting and educating micro business owners. Upcoming Freelance Camp events include: San Francisco Bay Area (Santa Cruz) - August 15, Bremen/Leipzig/Nurnberg, Germany - October 17, and more. For more about upcoming Freelance Camp events, hosting your own event, and other information, head over to FreelanceCamp.org.