Being self-employed is sometimes like walking on a treadmill.
—Andy Winn
If you are or ever have been self-employed or in a sales position where you are paid by commission, you might recognize the term “mystery means.” That is the condition of never knowing from one month to the next what your income will be, if at all.
I have discovered over the years that this condition of irregular income is one that keeps many people stuck in debt and unable to effectively manage their personal finances with any hope of getting ahead.
Overview
If you are a freelancer, a consultant, or work in sales, the arts, or some other form of self-employment and don’t know when or how much you’ll be paid from month to month, you live on a kind of financial roller coaster. You may have dismissed a couple of the 7 Rules as not applicable to your situation because, “If I don’t know how much is coming in any given month, how can I plan for how I will spend it?”
The majority of those who fall into the irregular income category live in constant uncertainty. Some months there is absolutely no income and then a deal closes or a big account comes through with a good-sized check. It is easy to forget the lean months you just survived, or to recognize that there may be many more ahead.
I feel your pain, and I completely understand what you are going through. My husband and I have been self-employed for many years so this irregular income situation is not foreign to me. And I believe I have a plan for you that will help you take the peaks and valleys out of your income stream and put you into a perfect position to apply the 7 Rules to your life.
To qualify as one who is self-employed for our purposes here, you do not have to own a business. I consider self-employed anyone who attempts to earn a living as an entrepreneur, small business owner, freelancer, distributor, consultant, entertainer, artist, or commission sales—basically, anyone who cannot predict with certainty the amount of his or her next paycheck, I will refer to herein as “self-employed.”
Two Parties
In any employment situation there are two parties: employer and employee. As a self-employed person you are both. You have “hired” yourself so now you must supervise, manage, and pay yourself too. You must learn to wear two different hats: one that reads You the Employer, the other You the Employee. You cannot wear them at the same time because employers and employees think and operate differently. You must also learn how and when to switch hats.
Wanda, Wilson, and Widgets
Let’s say your friend Wanda works for Mr. Wilson, owner of Widget World, Inc. Her salary is $40,000 a year, paid monthly.
The widget business is seasonal. Mr. Wilson sells far more widgets in the winter than the summer months. Wanda is a diligent employee, and while she knows the seasonality of widgets, it doesn’t concern her. That’s Mr. Wilson’s business. She has a job to do, she does it well, and she collects her paycheck on the first day of every month, month after month after month.
Because Wanda has a “real job” she can predict her paychecks and is confident that even during her employer’s slow months, she will still get paid.
So how does Mr. Wilson run this business and keep everything together when he really doesn’t know from one month to the next how much money his widget business will generate? I’m sure you’re way ahead of me here, but I’ll tell you anyway: Mr. Wilson is careful to build up reserves. He does not spend all of the company’s income during the good months, so he has cash available in the slow months to keep paying Wanda her monthly salary and his other business expenses too.
You, You, and Your Business
As a self-employed person, you have to be both Mr. Wilson and Wanda. You must do double duty. You work for yourself so you have to wear both hats. How foolish it would be for You the Employee to demand all of the money that You the Employer bring into the business each month. This is why the two of you need to sit down and negotiate a fixed salary that You the Employer can afford to pay and You the Employee can afford to live on.
The First Step
As a self-employed person you must determine what is the least amount of money you must have every month to live, not the most you can possibly wrangle out of You the Employer.
If you created your Rule 5 Spending Plan, you know how much that is. It’s a bottom-line number that includes Rule 2 Saving, Rule 3 Giving, Rule 4 Reserves Payment, your rent or mortgage payment, transportation, insurance, food, and so on. Let’s say you determine that you cannot live on less than $3,000 a month. That is the least that You the Employee must receive each month if you are going to work here.
Can You Afford You?
You the Employer must determine if your business can reasonably commit to hiring a $3,000-a-month salaried employee. Let’s assume that you can, so you offer You the Employee a job.
Separate Funds
No matter how small or part-time your self-employment situation is, the secret to your success will be in maintaining a separate checking account for your business. You should never deposit personal funds into it or pay for personal expenses from it.
Two Scenarios
Scenario #1: Let’s say that you are a self-employed freelance writer. You receive royalty checks from your publisher every quarter, you write for several magazines and receive checks from them each month, and you do copyediting for a publishing company on an as-needed basis. You get checks at random times for all of these different writing jobs, contracts, and assignments, and they come payable to you as an individual. They look like paychecks.
Your husband gets paid each Friday, so you hold any checks you’ve received during the week until then and make one deposit to your personal household account because he is not self-employed. But your checks from your freelance writing, even the pathetically small ones, are technically business income, not personal funds.
Mr. Wilson does not allow Wanda to take checks made payable to Widget Word, Inc., and deposit them into her personal checking account. That would be ridiculous. And you should not be paying yourself with checks you receive in payment of work you do (even if they are made out to you personally).
You must recognize the difference between business and personal income if you expect to make a success of self-employment. You must have a separate checking account into which you deposit business income and from which you pay yourself a salary.
Scenario #2: In this situation, let’s say you are employed as a commissioned salesperson. Your company issues you “paychecks” but only as you earn a commission. They withhold taxes just as they do for their salaried employees.
You start off the year with a bang by generating a $10,000 commission check. You deposit it into your regular household account. In February you receive nothing even though you’ve worked hard. Nothing again in March.
In April you receive four checks for $1,550, $1,200, $4,000, and $850, all of which go straight into your personal checking account and not a moment too soon. That’s $17,600 for four months. Because all of your commissions come from your employer, you think of them as paychecks.
The problem is, in January you had to play catch-up on all of the holiday bills that you couldn’t pay because December had been a “dry” month. You had to cover late fees, overdraft fees, plus bring all of your utility bills current. And there were all of those great after-Christmas sales. You felt as if you had extra money because you knew about that big commission check coming in January, so you splurged.
Along comes February and March with no income. Your personal checking account is depleted even though you are working hard and closing a few deals. You call the credit cards into action, and it’s desperation time again until April. The four checks you get in April ($7,600) are barely enough to catch you up. You enter May with a big fat $0 in the bank.
The Way It Should Work
This is how the self-employment situation of Scenario #2 should be handled.
First, even though you are an employee of a company that pays you by commissions, you need to open a checking account that you designate to be your “business account.” This is separate from your personal household bank account.
The January $10,000 check gets deposited into your business checking account. You guard this account from You the Employee as any good business owner would. Employees should not have direct access to business funds. Even if there are household needs and expenses, you do not use a dime of that $10,000 to pay for them directly.
On January 15, your “payday,” you write out a paycheck for $3,000, regardless of the balance in the business checking account. You deposit this into your personal checking account. This is difficult because you really could use some more money to get through January, and there is money sitting there in your business account. But You the Employee cannot expect a raise every month, in the same way Wanda does not expect one from Mr. Wilson even when she could use more money and knows he has plenty.
You get $3,000 on payday and that’s it until next payday.
On February 15, you write yourself another $3,000 paycheck from the business account even though you’ve had no business income this month.
On March 15, you write yourself a $3,000 paycheck. On April 15 you deposit the $7,600 commission checks into your business account and write yourself a $3,000 paycheck. Your business account is never depleted.
Now you know the secret for how to turn mystery means into a predictable and regular paycheck. This, too, is called money management.
Give Yourself a Raise
In time, as things continue to go well and you’re able to build sufficient reserves, You the Employer might decide to negotiate a raise for your favorite employee. But don’t be too hasty.
Weigh the pros and cons. Consider the position of the prudent employer against the needs of the employee. Employers cannot afford to deal from emotion. They must consider the best interests of both the company and the employee.
The wise employer knows that if the company goes under that will be infinitely worse for the employee than a pathetically small raise.
Successfully Self-Employed
As a self-employed person, your biggest challenge will be the temptation to live it up when a big check comes in. Worse, you will be tempted to multiply your best month by 12 and convince yourself that is your annual income. Let go of that. The only way that you can establish your annual income is by looking at your past years’ tax returns and taking an average. That’s reality.
Your success as a self-employed person lies in your ability to discipline yourself to be a fair yet strict employer and at the same time a grateful, restrained, and patient employee. You the Employee must become ultra-conservative and fanatically frugal even when you have seasons of financial success. You need all the financial reserves you can amass in order to move yourself away from the edge and never knowing for sure how much you’ll be making next month.
If your business is unable to pay You the Employee a living wage (in money, not credit), it’s time to decide if you have a viable business or if this is a hobby that might one day be a business. A business’s ability to pay its employees and expenses is what makes it viable.
If you determine that you have a hobby but you need a paycheck, go to work for someone who can afford to pay you. When your hobby becomes a viable business, you’ll be able to offer yourself a real job.
Recap
You level out the extremes of the self-employed roller-coaster ride when you: