A predictable month-to-month income just doesn’t happen for a lot of people. Your financial life could be that of a salesperson on commission, or an entrepreneur just getting a business off the ground, or a freelancer who’s constantly moving from one contract to another. There are lots of reasons for an irregular income. But even if you have one, you can be sure your bills will still arrive on a regular basis and have to be paid. If you want your exciting but unpredictable financial life to take on the consistency that comes with the routine of a steady paycheck — it’s vital to know how to budget with variable income.
Here are five good ways to accomplish that:
1. Add up your monthly expenses
The first thing to figure out is how much you spend each month. Break down your expenses according to whether they are recurring, or one-time. Don’t forget to include your spending on everyday items, or splurges. You want to have a general idea of how much you spend each month. This is the foundation of your budget.
A free online budgeting tool, like Mint, can be invaluable in creating your plan and tracking your expenses automatically. You start a free account, provide your checking account information, and the tool tracks the money you spend and categorizes it by the criteria you’ve established. The only thing you’ll need to add manually is your cash expenses. The more automatic your budgeting, the more likely you’ll stick with it.
It’s very important to prioritize your expenses. That way you make sure the most important debits are covered first. Bills, groceries, and debt payments are among the most important spending categories. Once you’ve set these priorities, you’ll know what you set aside dropped from the list if you have a lean month. Know ahead of time what you can cut back on if necessary.
2. Know the sources of your income
You also need to know where your money is coming from. Do you have multiple jobs? If you are self-employed, what percentage of your income is from a specific source? Document your income so that you have an idea of what you earn.
If possible, look at what you made in the last 12 months. Divide that amount by 12. This is a great way to estimate your average monthly income. If you made $48,000 over the last 12 months, your average is $4,000 a month. With a variable income, though, you might earn $5,000 one month, and $2,500 another month. The overall average, though, gives you a solid number to work with.
Many self-employed professionals have a problem with getting their clients to pay on time. They want to avoid having to be pushy for fear of alienating clients and losing further work. One solution for late payers is to make prompt payments profitable for them. You can offer clients incentives in the form of declining discounts the longer they take to pay. Try sending an email or letter to clients with a positive announcement of this form of discount offer and add it to your invoices. It’s an approach that will accelerate payments better than pushing for them.
3. Give yourself a regular salary to make planning easier
You can pay yourself a salary by opening two bank accounts — a checking account and a savings account. Every time you receive money, deposit it into your savings account. Then, every week, two weeks, or monthly, transfer the amount you estimated above into your checking account and use it to pay your expenses and fund your goal. When you have good months, you’ll build your savings. In less successful months, you’ll draw from your savings to keep your salary steady.
With this system, if you have a big savings balance at the end of the year, divide it by 12 and give yourself a monthly raise. If you don’t have enough in savings to make it work, you’ll have to take a pay cut and take a hard look at your expenses so you can stay on track to meet your goals.
4. Keep expenses in line with the monthly average
Once you have your monthly average, base your spending plan or budget on that income. Look at your expenses, and cut out the least important items so that your spending is in line with your monthly average. Plan your retirement contributions, spending on luxuries, debt repayment, and other spending, so that you can live within your means on your average income.
Every six months, re-evaluate your average income. You want to make sure that it is still fairly accurate. If your average income is dropping, you’ll want to cut from your lower priority spending from your budget. If your average is on the rise, you can adjust your spending plan so that more money is going toward retirement planning, or debt pay down.
5. Lay the groundwork for your future
The key with budgeting on a variable income is to plan for the future. Once you have your average, you can plan around that. On good months when you earn more than the monthly average, you can put the difference away in a special, high-yield savings account. In our example above, if you have a good month that earns you more than $4,800, you would put the difference between your earnings and the monthly average in an account. Each month that yields more than your 12-month average should provide you with a cushion to help you through the poor months.
On months that you don’t earn as much as your average, it’s always best to try to cut back a little bit. See if you can avoid some of your more frivolous spending. Then, once you have made that effort, you can dip into your cushion to make up for any deficiency.
When your income changes from month to month, paying attention to budgeting is even more critical for you than it might be for a salaried professional. Be aware of where your money is coming from, and where it is going. Build up a cushion so that in down months you aren’t digging a hole of debt for yourself. A little discipline will go a long way.
Learning how to budget with variable income takes effort and time. It means making your income and expenses predictable and consistent. But it’s well worth it when you escape fees from bounced checks, credit card interest, late payments, and poor credit reports. It’s also worth it when you enjoy the resulting peace of mind.