The Freelancer’s Survival Guide: Money, Part Three
Kristine Kathryn Rusch
The money topic. As I mentioned two posts ago, it’s difficult for Americans to talk about money. And these last few weeks have borne that out.
The moment I mentioned money, the comments slowed, the e-mail stopped, and so did the donations. If it weren’t for the website statistics and Twitter, I would have thought that people had stopped coming to my website.
Instead, tweets pointing out the posts have abounded on Twitter (thanks y’all) and the number of unique visitors to my website has gone up dramatically since I started the posts about money.
But the silence has been deafening. I’m not sure if that’s because y’all are waiting for me to get through the entire money section before commenting, or if you’re stunned at my candor, or terrified by the actual economics of freelancing.
I’m sure I’ll never know exactly.
So…in the face of this silence, I’ll soldier on, and continue my discussion of expenses.
If you haven’t read the two previous posts on money, go read them now. http://kriswrites.com/2009/06/11/freelancers-survival-guide-money-part-one/ and http://kriswrites.com/2009/06/18/freelancers-survival-guide-money-part-two/ I’m going to be building on them.
In last week’s post, I had three versions of an equation, the freelancer’s financial equation. (The equation, really, that defines all businesses.)
Gross income – cost of doing business = net income
But, I pointed out, that for many freelancers, the actual equation goes more like this:
Gross income – cost of doing business = zero
Gross income – cost of doing business = net loss
Let’s define terms.
Gross income is all of the income that arrives at your business, from the smallest pennies to the largest checks. All of the income without exception. If you earned the money through your freelance labor, then it gets counted as part of the business’s gross income.
We are only discussing the income that comes into your business, not the income that comes into your household. For many freelancers, that’s a tough distinction. Early on in freelancing, the money you made at your part-time work was bonus money, used to splurge on dinner or perhaps buy a nice pair of diamond earrings for the wife.
I would hope that before you became a fulltime freelancer, you learned how to separate your freelance income from your belief that it’s all bonus money and yours for the taking.
If not, you’re already in a world of hurt, and probably don’t even realize it.
A lot of freelancers, however, only count their primary freelance income as gross income, and that too is a mistake. For example, fiction writers make a lot of money from a variety of sources, from New York publishing houses to audio sales to foreign sales. Some writers believe that checks under $100 are bonus money. Others think that sales from other countries are bonus. If you make money in a way that is somehow tied to your business (selling extra copies of your own books on eBay, for example), then that money is all part of your gross income.
I can hear some of you complain now. You don’t want to keep track of the tiny checks, or the twenty bucks someone hands you for a hard-to-find copy of your novel. Too bad. Set up your accounting system so that you can keep track of every dime. Even if it isn’t important now, it will become important later.
The cost of doing business is precisely that. How much does it cost you to run your business?
Break this down into finite units, depending on your business.
If you have a retail store or an office outside the home, I would break this down into the smallest possible unit: How much does it cost you to run your business every single day?
Some businesses can get by with knowing that figure for the entire week.
Most businesses keep track of costs by the month.
A few keep track by project. (How much did it cost you to do that particular client’s job from start to finish, including overhead?)
For the sake of this piece, I’m going to go over general monthly costs. I do realize that each freelance business is different. I can’t write a piece that will include all the expenses plumbers incur and a piece that will include all the expenses criminal defense attorneys incur.
But I can speak about expenses in general.
Overhead: overhead is the general recurring costs of running your business. Remember last week that I mentioned I realized that even by breathing, we were all incurring expenses? To a business, that’s the overhead.
Overhead includes those expenses that happen even if you’re earning no money at all. Those expenses include (but are not limited to):
2. Utilities, including telephone and internet (and cable, for those of us who are freelance storytellers or freelance reporters).
3. Salaries (your salary as well as the salaries for any employees)
4. Vehicles/large equipment (trucks, tractors, large machinery, etc.) (I’m figuring that you’re amortizing the cost of these machines over the year, instead of writing off the cost of purchase in the month it occurs.)
5. Office equipment (computers, printers, photocopiers, etc.) (Again, see the note for #4)
6. Supplies (the monthly things you need to keep all of that running)
7. Maintenance (from equipment maintenance to janitorial services)
8. Business insurance(s)
9. Taxes. All of them, from sales tax to property tax to social security tax.
Costs per project: People who own storefronts usually don’t have this issue but the rest of us work on a piece-work basis. We don’t get paid a salary (except through our own business). We generate income by finishing projects. Each project will have general, predictable costs, and several unpredictable costs. All projects also have basic costs that most freelancers ignore. These costs include (but, again, are not limited to):
1. Materials specific to the project. For example, a friend of mine makes quilts. She has fabric, thread, batting, and all the other things she needs for the average quilt, but if someone wants a quilt made from a specially imported silk, that silk would be specific to this project.
2. Gas/transportation/travel expenses/meals. Any errands you do associated with this project and this project only, you should include a per diem expense for the vehicle used or the exact mileage and cost of gas. (For example, most writers never count their mileage to and from the post office as part of the expense of a particular project. But they should.)
As for travel expenses and meals, the IRS has rules as to what can be deducted. But we’re not discussing the IRS here. We talking actual cost. So include the full price of business travel per project, as well as the full cost of each meal.
3. Cost overruns: You should know how much each project will cost to complete. Projects sometimes cost more because the client demands something new or because the project is bigger than initially predicted. Those overruns need to be included in cost per project.
Note: I should include time as part of the cost per project. I am not going to here, because we’re discussing actual cash outlay. But time is an important part of project costs, and I will get to that in a later section. Because time is, essentially, what we freelancers bill for.
But right now, we’re talking internal costs and I trust I’ve taken care of the cost of your time in overhead with the inclusion of your salary (hint, hint).
Other important business costs. I almost called these hidden costs of doing business, but that’s a whole different section. This category, important costs, often includes the expenses that make or break your business.
1. Continuing education. Many professions require a certain amount of continuing education from the practitioners so that they can keep their license. Many state bars require continuing education from attorneys. Most hospitals require continuing education from their doctors (and damn, I wish that was all hospitals).
Freelancers should always continue educating themselves about their business. Sometimes that means attending a class. Often it just means keeping up with the current materials—books on the latest trends, subscribing to the trade magazines, etc.
2. Advertising/The cost of finding new business. Not every business has or needs an ad budget. For example, freelance writers never advertise on the radio. Plumbers sometimes do. Lawyers never used to, but they seem to own late-night television now. (Do they think the sleepless are more inclined to sue?)
But we all have to generate new business, whether that’s through designing and maintaining a website or handing out business cards at the local Rotary luncheon. This doesn’t go into overhead because, for most of us, it’s not a consistent expense, but it does have to go somewhere, which is why I put it here.
3. Advice. Many freelancers engage the services of other professionals to help with particular business matters. They hire freelance accountants to handle their year-end taxes. They hire attorneys to handle a particularly annoying problem. They hire real estate agents to help them buy a new office complex. Freelancers can often go months without paying for advice, but they rarely go years without it. Again, amortize the cost of the advice, and include it into your monthly expenses.
Of course, that’s not all of the costs of doing business, but that’s enough for a general start. You know what your business entails. Sit down and make a list of all the costs—again, from the smallest expense (the cost of the newspaper you buy for fifty cents every day at lunch) to your largest, and then break down those expenses by month. That will give you the monthly cost of doing business.
Subtract that cost from your monthly gross income, and you’ll get (I hope) a net income.
If you don’t, look at last week’s essay.
Notice how many fixed costs there are to running a business? More than most people expect, especially when they started making quilts for friends and then decided to go fulltime with an entire business.
For first-time freelancers, the expenses are often a big shock. As I mentioned in one of the early sections, when you work a day job, you never think of the overhead expenses. The office exists. The lights are on. The phones work. Those things don’t really matter to you, the employee, so long as you get your paycheck on time.
As a fulltime freelancer, you’re now responsible for the phones, the lights, and the office, as well as everything (and everyone) in it. That’s quite a change, and it’s often a difficult one.
Now let’s note what I did not include in expenses.
I didn’t include your house payment or the payment for the car your spouse drives exclusively. Nor did I include the cost of your kid’s ballet lessons.
Personal expenses come out of your salary. Got that? They don’t come out of the cost of doing business. Here’s a pretty solid rule of thumb for you: If you can’t legitimately deduct the expense from your business’s income tax, then you can’t pay for that expense with business funds.
Think of it this way. If you still had a day job, would you ask your boss to buy your groceries? Your boss would laugh at you and remind you that’s what you get a paycheck for.
I can’t be more specific than that. If you’re a fashion designer, then clothing is a business expense, just like theater tickets are when you’re an actor. Each business is different and has different needs. For me, books are a legitimate business expense. But all books wouldn’t be a legitimate business expense for a gardener. Only books on gardening and related topics would be a business expense for him.
Why am I tell you this? Because freelancers horribly intermingle their personal finances with their business finances. You have to keep them separate.
I know most of you work at home. That’s where the trouble starts. You work at home, your family lives there, and you think nothing of intermingling your expenses with theirs.
You can’t intermingle. It has to remain as separate as it was when you had a day job.
You’re going to have to start thinking in percentages. Figure out what percentage your office is of your house’s square footage. For easy math, let’s say that your office is 25% of your family’s house. You only use that office for your business. You don’t store exercise equipment there, or keep your son’s drum set in the back closet. Just your business.
Then 25% of your house payment is your rent for your office. Just like 25% of the electric bill and 25% of the water bill and 25% of the heating bill make up your utility costs for your office. Got that? Be scrupulous about this—and take pictures of your office, so that at tax time, you can prove that you use that office only for your business.
(Please remember here that I am not an accountant or a tax attorney. I’m just a humble freelancer with too much life experience not to share some of it.)
Try to have a car that you only use for your business. Otherwise you’re going to have to figure out usage either by project or daily use. You’ll need a contemporaneous log. That goes for other items with shared uses. Try to keep shared items to a minimum. I know you can’t always do that, but do your best. And when you must share, be very, very clear about how much you used that item.
The personal items problem is the very reason I’m telling you to take a salary from your business. It makes things very simple. The easiest way to do this is to keep a separate business bank account and never ever use it for personal items. Write yourself a salary check every month, and put that money in your personal account. Treat it the way you would treat your paycheck from your day job. When that salary money is gone, it’s gone, even if there is extra money in the business account.
Believe me, that accountant you hire at tax time every year will be much happier with you if you do things this way. So will the IRS auditor if you are ever have to face that music. (And let me tell you, as a person who has had two full audits, it’s really not as bad as the press makes it out to be. Yes, it takes time from your life, but if you’re organized and diligent in your record-keeping, you’ll survive just fine—and live to freelance another day.)
If you subtract those costs of doing business from your gross income, and come out with a net loss, then you need to make changes. The change you cannot and should not make is to cut your own salary.
I’m sure many of you wondered how month after month a fulltime freelancer subtracts the cost of doing business from his gross income and comes out with nothing. The way most fulltime freelancers make that second equation work is by cutting out their salary and letting their spouse handle the personal expenses. All of the personal expenses.
The freelancer’s business—without the cost of the salary—breaks even. Which means, that if you add the salary back in, the business is operating at a net loss.
Which cannot and should not be sustained over time.
I’ve gone two weeks now and I have not discussed that lovely phrase net income. So let me simply say here that most long-term full time freelancers have a rather large net income. We wouldn’t stay in the business if we didn’t.
But a net income creates its own problems.
I’ll deal with those problems—and the positives of freelance income—next week.
“Freelancer Writer’s Survival Guide: Money, Part Three” copyright 2009 by Kristine Kathryn Rusch.
You can now order either an e-book copy of the Guide or a trade paper copy of the Guide. It’s in slightly different format and has been organized, so that related topics are in an easily accessible place.
You can get the print version here.
For those of you who’d like to buy an ebook, here’s the Amazon link as well as the Barnes & Noble link. The e-book will also be available on all the other e-book sites. If you want it in your favorite format, and the book hasn’t yet been uploaded to your favorite site, try Smashwords. You’ll be able to download in a variety of e-book formats.