Exploring how you can take away some of the risk of being a freelancer and improve your financial resiliency
Freelancing offers flexibility. It’s a way to fit in the necessity of generating an income, with the other things you want to achieve in life. But for all this potential happiness, freelancing does have its drawbacks.
In this article I explore the loss of security that comes from transitioning from the employee world into freelancing, and the strategies you can deploy to mitigate these very real negatives. In essence, what we want to achieve is the freedom of freelancing, with the security that comes from being an employee. The best of both worlds.
So what are the things you lose when you make the jump out of the employee world, and into freelancing? I’ve identified 5:
- Predictability of cash flow
- Sick leave
- Protection from being sued if you make a mistake
- Retirement savings
- Professional development
Let’s step through how you can be a freelancer, but still gain access to these benefits.
Predictability of cash flow
As an employee, a significant comfort comes in the knowledge that every second week, a predictable lump of money will be dropped into your bank account. As a freelancer, especially early on, it’s very feast and famine – lumps of money come in on an irregular schedule. This can be stress inducing, and is often a key reason talented people don’t make the leap to freelancing. So how to defeat this problem? I call it Bucket Strategy+ .
In an employee situation, a Bucket Strategy entails having typically 3 bank accounts, with money automatically allocated across each to provide for savings, bills, and livings costs.
As a freelancer you need version 1.1 of the standard strategy, what I call Bucket Strategy+. Over the top of the normal bucket strategy, you first need a business account, where all of your business revenue comes in, and all of your business expenses go out. You need a bit of a float in this account in order to manage the natural lumpiness of your freelancing income. You may even need a small overdraft facility attached to this account.
With your separate business account set up, and a comfortable float, you are then able to pay yourself a wage, just like you were an employee. So you set up an automated fortnightly transfer into your main personal bank account, and then run the traditional bucket strategy, as you would have as an employee.
The Bucket Strategy+ can solve your personal predictability of cash flow problem, but of course for it to work, you need to ensure that the amount you are drawing out of the business account as wages is something that’s affordable to your business. For this reason you need to monitor cash flow. I use Xero for this and find it excellent. Myob and Quickbooks are other popular alternatives.
From whichever package you use, check your profit and loss each month to see that what you’re taking out isn’t excessive. Check your business bank account balance more regularly, perhaps every 3rd day or so depending on how much activity you have, to hold a general sense of where you cash position is sitting. Be mindful of the quarterly cycle to pay your BAS, personal taxes, and perhaps super. These are due 28 days after the end of the quarter, so you should be seeing the cash in your business account building up to this date.
In terms of resiliency, be really cautious about the debt obligations that you take on, especially concerning cars. I regularly come across people who sign up to a 4 year loan for a sexy new car during a period of business buoyancy, but then discover the repayment obligations to be a real weight around the neck 15 months later when conditions have changed and work is less abundant.
It is a comfort as an employee to know that if you can’t work for a period, your fortnightly pay will still drop into your bank account. Most employees have 10 days paid sick leave available per year.
So how to replicate this as a freelancer?
Short term sick leave needs to be provided from your business account. This highlights a reason why you need a good float or buffer sitting in this account. With your Bucket Strategy+ in place, every fortnight your wage will come out of your business account, and into your personal account, whether you are fit and productive, or laid up in bed with the flu. So in this regards, it’s just like being an employee.
But of course, as a freelancer, if you’re not working, then money’s not going to flow into your business account, so eventually this arrangements will breakdown.
The solution here is Income Protection insurance. Income Protection insurance replaces 75% of normal income if unable to work due to illness or injury. Most commonly it comes with a 30 day waiting period, though it is possible to get 14 day waiting periods, and longer periods too. The waiting period is the length of time you need to be unable to work, before you can start claiming a benefit.
So as a freelancer, with the Bucket Strategy+ and Income Protection in place, short term illness will be covered from your business account float, and longer term illnesses will be covered by your Income Protection policy. Most Income Protection policies pay benefits through until age 65, so it is potentially very long term cover if that ever became needed. Having it in place certainly provides peace of mind – you know you have that safety net.
There is also Life, Total and Permanent Disability, and Trauma insurance that all have a role to play in your robust financial safety net.
Protection from being sued if you make a mistake
In some roles, this risk is more obvious. We have a freelancer working from one of our spare offices who is a fire engineer. When he was an employee, if he made a mistake with some calculations and catastrophe later struck, his home and other personal assets were not at risk. But as a self-employed freelancer, they could be.
Now most freelancers don’t have such obvious potential for being sued, but what about the IT consultant who crashes a customer’s server causing them to lose valuable data? Or the conference attendee who trips over your cables whilst you’re videoing the event, and sues for her injuries and lost income?
As an employee, your employer acts as a protective shield, but as a freelancer, you are exposed.
Professional indemnity insurance, and general indemnity (public liability) insurance provide the answer here.
It may be worth contacting an insurance broker for these covers. They can provide advice as to the best structure and the options available. Cover for issues such as cyber-attack, can be added to these policies if they are relevant to your activities.
You should also talk with your accountant about asset protection strategies. The use of companies, trusts, and the strategic placement of assets can all help protect you.
We live in a world where we need to provide for ourselves in our old age. Government pensions become less generous with each passing year, and the demographic reality of an increasingly aging population mean that trend is irreversible. We need only look at the collapse of the Greek economy in 2010 to see what an unsustainable government pension system leads to.
There will come a time when you are no longer willing or able to continue doing income producing activities. It is crucial that freelancers don’t neglect the importance of continuing to build savings for their retirement, whenever that might be.
Automation is your friend here. Set up an automatic transfer from your business account across to your retirement savings account, so that this happens without you having to think about it.
What many of my clients do is have a certain base amount transfer across each month, and then close to the end of the financial year, they contribute a top-up amount depending on what sort of year they’ve had financially. Some do these top-ups quarterly.
You should be aiming to get around 10% of your normal income across into your retirement savings account.
The final component to plug into your freelancing safety net plan is professional development. One advantage of being an employee is that you often get opportunities to attend training sessions, or learn other team member’s roles.
As a freelancer, there is the potential to stagnate.
The late, Peter Drucker, US management consultant expert, observed that knowledge has an expiry date. “A knowledge worker becomes obsolescent if he or she does not go back to school every three or four years.”
So how can you overcome this potential for obsolescence as a freelancer? Firstly, have in your business budget an allowance for professional development. Almost anything you want to do will cost money, so the first thing is to ensure that funds are available, and lack of money isn’t a barrier.
Next, look for industry conferences, professional meet-up groups, or industry publications, which you can engage in. Take your professional development seriously – investing in your skills likely has a very positive long term payoff, so it’s not something to be ignored.
Before we wrap up I’d also like to share with you a strategy I’ve found very useful over the years in my business. It’s called Worst Case Scenario Planning.
If you’re worried about something, take a moment to write down a few outcomes in the event your worst case should occur. Next write down what you would do if they were to occur.
So for instance if you’re worried about a key debtor going broke, then a worst case scenario might be having to write off $20,000. What would you do? Would you need to dip into your overdraft facility? Maybe you could delay your normal superannuation contribution and hoard the cash until you see how things play out (I’m talking here about your personal super contributions, not your staffs if applicable, they must be paid).
If you’re a homeowner perhaps you rely on your redraw capacity to cover you for a time. If it was a really large write-off, perhaps you sell up and rent somewhere for a while.
Everyone’s scenarios and solutions will be different, but the point is that by running through these and having a plan, even a fairly unpalatable plan, you can relieve a lot of stress. Also, having identified these potential worst cases, you can think about strategies in advance to reduce the chance of them occurring in the first place (eg. not being too exposed to any one single client), thereby achieving our goal of increased financial resiliency.
I hope these ideas can help you. It’s challenging times at present, but they won’t last forever.