This shouldn’t be a big surprise to anyone who’s ridden in a Lyft, or ordered through Postmates, or used Fiverr, TaskRabbit, UpWork, or a thousand other similar services; there are more freelance workers than ever before. In fact, according to a survey by UpWork, there were 55 million people who did some sort of freelance work in 2016 which translates to 35% of the US workforce. This is an increase of 1 million people from 2015.
With that many new freelancers starting out each year, it’s no wonder that many are having trouble managing their finances properly. A recent report by Elevate’s Center for the New Middle Class revealed that for Millennials with credit scores below 700, 72% were “likely to learn financial skills via trial and error.” Yikes! Personal finance isn’t something you really want to stumble through. So let’s take a few minutes and break down the top 5 money mistakes freelancers make.
1. Not being on top of your taxes
Wait! Don’t fall asleep yet. We know that taxes are a complicated and boring topic, but for freelancers poor management of taxes is by far the number one money mistake. The good news is that if you do it right, you’ll usually pay less in taxes come April since you’ll avoid penalties, fees, and can take proper deductions. The bad news is that for new freelancers, dealing with taxes is annoying and intimidating.
This is a big topic, and we’ll probably dedicate a future blog post to this issue (or you can check out our free ebook on the matter) but for now, let’s highlight some steps you can take today to manage your taxes:
- Realize that taxes are a thing — Freelancers usually take home the full paycheck so it’s your responsibility to save a portion of it for taxes. More often than not, new freelancers just don’t realize that they have to do this, or just how much they’ll need to save. Start with broad strokes according to the current Tax Bracket. Say you fall into the 25% bracket. This means you’ll roughly owe $5200 + 25% of what you make over $37,950. For a $50,000 annual freelance income, that means you’ll owe about $8200 in taxes (before deductions). So plan to save around that much by April as a baseline of what you may have to pay.
- Start paying Estimated Quarterly Taxes — This means the IRS wants you to pay what you think you owe every three months. Why? Because the tax code was written for full-time employees in traditional 9-5 jobs and they haven’t caught up to the times yet. But thems the rules. Use their handy form (1040-ES) to help you break down what you’re estimated to owe, and you can use the IRS’ Direct Pay system to fork over your American dues online.
- Keep track of your expenses — You won’t know what you can write off if you don’t keep track of what you spend money on. Start tracking your expenses and hold on to your business receipts to make life easier when you’re itemizing your deductions. It’s best to use a dedicated platform to do this, but if you’re willing to put in the time, there are Excel templates you can use to help track your business costs.
2. Not separating business and personal accounts
Even if you’re a full-time freelancer, you often won’t need or want to incorporate into an actual, legal business entity. But that doesn’t mean you shouldn’t treat your finances like you’re running a business. One big mistake freelancers make is to maintain just one checking account and one credit card for both personal and business income/expenses. Again, it’s a small upfront effort (and maybe cost depending on the checking account you want to open), but it’ll pay off in the long run.
First off, a separate bank account will help you organize your income and expenses that are solely from and for your business. If you get audited, if you hire an accountant for taxes, if you need to budget for your business, if you need to calculate estimated quarterly taxes; all these get measurably easier (and faster) if your business financials are all in one place uncluttered by your personal transactions. This can even save you money. For example, keep in mind hiring a tax professional is often expensive; if you can save him/her even an hour’s worth of time by handing over access to just your business account, then you’ve already saved yourself between $25 to $100 in their hourly rate.
The same goes for having a business-only credit card. While new freelancers probably won’t need an actual business credit card (they’re only good for high expenses and often come with annual fees), you should still open another personal credit card to separate out your freelancing costs. Again, this will help you itemize your expenses and keep you organized, but there are other benefits too:
- Build up your credit score
- Separate credit limits for large purchases (ie. vacation vs desktop computer)
- Fraud protection (if one is stolen/hacked, the other is safe)
As long as you are good about paying off the balance each month, a separate credit card for business expenses is a smart move to make.
3. Relying too much on one source of income
Like many things, freelancing can succumb to the 80/20 rule where 80% of your income can come from 20% of your clients. In fact, a lot of people get into freelancing because of that “one good client” that finally shows them that hey, this might be a viable career after all. But betting it all on one big client can fail overnight, and if you haven’t diversified your income stream, you could go from a surplus to zero quickly. For example, a survey by BrightLocal showed that Freelance SEO workers averaged 9 clients in 2015.
Yes, bringing on more clients is easier said than done, but think about it this way: finding new clients is part of your job as a freelancer. With this mindset, at least 5% of your work hours should be dedicated to acquiring new customers. Since it usually takes some time to bring a client on board, make networking and soliciting projects a part of your work routine. Some freelancers set aside 15 minutes a day for this; others have a “New Client Wednesday” mentality of setting aside an hour a week. Whatever it is, set a goal and incorporate the pursuit of more work into your schedule. And to put this in context, Contently.net did a survey in 2015 that gives some insight into how often freelancers are looking for new work:
Some push-back we hear is that many freelancers don’t have time to take on new clients at the moment anyway. That’s a good spot to be in, but it’s still prudent to make sure that one client isn’t making up 90% of your income. If that’s the case, it still behooves you to look to diversify and take on new work, even if it’s only one small project a month. Again, this is a safety net in case of something unexpected. So if you’re at 100% capacity with many income streams, you’re probably good. If you’re at 100% with just two clients? You need to push that down to 95% and start looking for more customers.
4. Not realizing clients can (and will) pay invoices late
This point often comes as a surprise to new freelancers, who will then in turn quickly understand that sometimes the money just takes longer than you expected to arrive. Freelance long enough and you’ll inevitably run into clients who will make late payments, for reasons both credible and …not. In fact, 71% of freelancers have had trouble collecting payments during their career, and 81% of these issues were late payments. 34% said they had instances of not being paid at all.
These are scary statistics, and it just means you need to be prepared for the sad inevitable. Here are some ways to stay afloat during late payments and deal with clients who are missing invoice deadlines.
- Have a safety net — Personal finance blogs will tell you to have 3 to 6 months of living expenses saved as your emergency fund. If you’re a freelancer, you should double that. Not only is a freelance career inherently more unstable than a 9 to 5 (hey, there’s a trade-off to being your own boss), but remember that taxes haven’t been taken out yet. And as discussed earlier, having a diverse income stream is also a safety net.
- Put payment terms in writing — Beginning freelancers tend to just have handshake agreements with their first clients. You should quickly get contracts down on paper to have some leverage when it comes to payment terms. The industry standard is net 30, aka 30 days from when an invoice is issued, but 21 days is also common. Many freelancers also add in a late payment interest clause in their contracts, with a typical fee being 1.5% interest per month.
- Be polite, but be firm — When clients are late, be as polite and professional as possible when you inquire about your payment. You never know what might be going on behind the scenes of their business. But you can’t be a doormat as well.
- Know your legal rights — You’ll want to avoid this if at all possible, but you do have the option to take amounts less than $10,000 to small claims court. There are fees, but if you expect to win, it’ll be worth it. And hey, if you’re a freelancer in New York, you’ve got some extra protection in the “Freelance Isn’t Free Act” (now we just need it in all 50 states!).
Unfortunately, these things happen and it’s important to go into freelancing with eyes wide open. Late payments can devastate your financials, so it’s prudent to have a game plan in place if/when it happens to you.
5. Not knowing what you’re worth
“Your hourly rate seems too low. How about X much more?”
Yeah, that maybe happens if you’re working for your rich uncle, but in the real world those sentences don’t come out of anyone’s mouth. That’s why it’s important to make sure you’re not undervaluing your work and especially your time. Remember, unlike traditional office workers, you’re paying for everything from these paychecks: meals, snacks, coffee, internet, phone, electricity, health insurance, retirement savings, transportation, etc etc etc. In this case, your hourly rate is a lot different than an hourly rate of a 9 to 5 employee with access to that ever-stocked snack closet.
There is plenty of evidence that freelancers are getting exploited. From having to do a lot of free work to industries that consistently undervalues female workers, the life of a freelancer isn’t for the faint of heart. It’s important to know what you’re worth, and just as importantly, what you want to be worth.
Figuring out your personal hourly (or per-project) rate is complicated, but it boils down to a simple equation to get an estimate:
(Living Expenses + Work Expenses + Profit) ÷ Billable Work Hours = Estimated Hourly Rate
The first two items are self explanatory. “Profit” is what you want to take home after paying out for everything you need to work and survive. This includes spending money, vacation money, and money to invest into your savings and retirement. Your “Billable Work Hours” is your estimate of how many hours you’d like to ideally work in an average month.
Of course, your hourly rate will have to be flexible. Maybe you need to lower your rate to start with a new client you really want. Or maybe more intensive clients require a higher rate. But with this equation and some research into the average rate for your profession in general, you’ll have a solid basis to begin to value yourself appropriately.
What money mistakes have you made in the past? Let us know!