Basic finances (and expense categories) for freelancers

My friend asked me how I keep track of my expenses and income as a freelancer. Here’s how I’ve set things up after 15 years (off and on) of working for myself.

The most important habit is to keep your business and personal expenses absolutely separate, so there’s less confusion at the end of the year. I have a business card and a personal card, plus a debit card for when I have to use cash.

• Use credit cards, not debit cards, for security — if (when) your cards get compromised, credit cards can refuse the charges, while debit cards give straight cash and sometimes charge you $50 for the fraud.
• Pay off your balance in full every month (duh) — it’s definitely the highest-interest loan you could have
• Try to get cards with no/low annual fees, that earn you miles or cash back. (Here’s a list of cards with rewards.)
• Every few years, call your credit card companies and ask them to increase the credit limit on your cards. It costs nothing, and increases your credit score (ht @swissmiss)

I pay my housing and healthcare costs directly from my checking account, since they dwarf all other personal expenses. It would be nice to get the miles/cash for them, but the variable personal expenses are easier to watch if they’re in their own scale.

Business expenses

Which expenses go on your business card? Here are the categories my awesome accountant uses on my taxes. I’ve put them in descending order of size.

• Office Rent — 100% of rented space, something like 30% of your home rent if you work from home
• Outside Services — hired contractors
• Office Expenses — hardware, software, hosting/DNS, supplies, moving expenses (Note: not furniture/furnishings)
• Conferences — fees, transportation, lodging, and food
• Telephone — phone and internet
• Research — books, magazines, television, news, events… this is often a very large category for artists and designers
• Gifts — gifts to clients
• Legal & Professional Services — lawyers and accountants
• Meals & Entertainment — Note: you can only write off your share of the meal, and only 50% of it. A former accountant told me to be careful on the “Meals & Entertainment” category — large expenses here are a flag that the IRS uses to trigger audits. In my expense spreadsheet, I keep track of who I was with, and their company/title or the topic we discussed.
• Miscellaneous — fees
• Travel — transportation to and from business events
• Postage
• Printing

(Please take my descriptions with a grain of salt, and confirm with your own accountant.)

Major deductions

You’ll also have the major expenses, which you might pay from your checking account if you can’t put them on your business card.

• Retirement Savings — Traditional, Roth, or SEP IRA (Ask your accountant about the differences, but the SEP has a higher limit. You can store up to about 25% of your income, tho I never get that high, and it reduces your tax bill by about 35% of the deposit… so if you put $10k into your SEP you’ll save $3500 on your taxes)
• Health Insurance
• Real Estate Taxes
• Mortgage Interest
• Student Loan Interest
• Medical Expenses — if they’re over a certain amount

(Usually you receive forms for these.)

Personal expenses

Everything else goes on your personal card. I’ve started trying to use the same categories each year, so I can see how I’m comparing to past years, and plan ahead more clearly. My categories, again in descending order of scale, are:

• Food & Drink — groceries, fast food (lunch/coffee), dining out, alcohol/bars
• Travel — family visits, retreats
• Fun — excursions, novels, cash (I’m trying to use less cash and track more)
• Clothing — shoes, accessories, general
• Home — furnishings, improvements
• Sports & Fitness — classes, workshops, equipment
• Transportation — bicycle, subway, cars
• Beauty — hair, nails, spa
• Gifts — family, friends
• General Merchandise — miscellanea

Tracking all this spending is interesting, but I’m not yet sure that it actually changes my behavior!

Income

You should have a separate checking account for your business, and all income should be deposited there (so there’s no appearance of embezzling). Your business card could then just pay from this account.

You’ll pay $1000 or more to get set up as an LLC or a corporation. This is a must; if anything ever goes bad with your business, you want the company to lose its assets, not you. Keeping a separate bank account is part of this protection, and required legally. Customers should make their checks out to your LLC, and they should be deposited in the account for the LLC, with no mixing of your personal and business accounts.

I use Freshbooks for all my invoicing, and Cushion for an overview of project income, duration, and delays. (Those are both referral links, for a free month.)

For your personal account, earmark your money so you don’t feel flush and start living too large. Some banks (e.g. Simple) will let you set up “Goals”, which are basically folders in your checking account. There are also apps (like Sweep) that let you do this. I used to just have multiple checking accounts at the same bank; it’s easy to move money among them. Your balance will look much thinner once you bucket the essentials:

• Emergency — three (if not six) months of savings, for times when clients are slow to pay or you unexpectedly can’t work
• Taxes — your accountant will tell you how much to pay in estimated taxes, once you have a baseline, but if it’s your first year set aside ~25% each quarter (ht @gblakeman)
• Bills — enough to cover your monthly expenses without risk
• Investments – I have a Schwab checking account so it’s easy to transfer money into my IRA or other investment accounts (they also refund all your ATM fees), and I try to save about 10% of my income

You can also set up folders for particular savings goals (like a trip or a house), or give yourself a “Fun” folder that’s a no-strings-attached allowance.

Reviews

Finally, it’s time to review and sort your expenses. I tend to do it around New Year’s, as part of a year-end personal review. It’s my version of looking through photo albums. Other people do it more frequently.

• Some credit cards (e.g. Chase) will send a year-end overview of your spending, auto-categorized (but it doesn’t exactly match the categories for your taxes)
• Some credit cards (e.g. Chase) only let you download the last 90 days of transactions. I had to set up a bi-monthly calendar event to remind me to go download my data.
• I just started using Personal Capital, which auto-categorizes some expenses for you (as do Mint and Simple), but it’s more accurate (and informative) to review all your expenses personally.
• If your expenses are more complicated, you might want to work with a bookkeeper — here’s an overview of bookkeeping if you want to be better.

I use Mac’s Numbers, which is similar to Excel, other people use Quickbooks. I group things into the categories above for my accountant, and then into sub-categories for my personal budgeting.

Budgeting

A few last notes about budgeting. Spending money can be stressful as a freelancer, since you don’t know how much you’re going to make each year. The first step is to know your burn rate (ht @fictivecameron). And then to compartmentalize. Just as it’s a skill to be able to leave your work stress at the office, it’s a valuable skill to leave your money stress for the decision-making times.

I split business expenses into “fixed” and “variable”.

• Fixed expenses are big decisions that you only need to make/review occasionally. Once you’ve chosen your internet plan, or your office, it doesn’t do any good to stress about it. Look at them yearly, and decide if you want to change them. (Then call Time Warner and haggle, you can get them down to $40/month with hardly any effort — ht @destroytoday)
• Variable expenses (like supplies or research) should of course be controlled (if you want to stay in business), but they’re deductible so they’re not quite as “bad” as personal expenses in terms of a freelancer’s budget. I give these decisions a day or two, but not so much stress.

I split personal expenses into “planned” and “unplanned”.

• Planned expenses, like trips, are the lifestyle needs or luxuries you can anticipate quarterly or yearly. If you’re watching your budget, you’ll want to convert the big unplanned/emotional expenses into planned/rational ones. One $400 splurge negates hundreds of careful frugalities. They’re good to review at the end of the year, to repeat or reduce.
• Unplanned expenses are the impulsive things (like food or clothes) that sneak in. Some apps, like Level, will let you set trackers to watch your spending in specific categories. (I find it easier to just set a baseline of NO than to keep track of all the trackers.) Little luxuries (like a coffee) are not always worth stressing about, but larger shopping/drinking excursions will definitely add up.

So you only have to look at fixed and planned expenses on a yearly/quarterly basis (when you’re clear-headed), and you can save your willpower for the variable and unplanned expenses — or more important things.

Hopefully this is a vaguely helpful template for people starting out. If you have any other tips or thoughts, let me know!