Budgeting for a Transition to Self-Employment

Posted on November 24th, 2016

Leaving your job for full-time self-employment is a huge transition. Walking away from a steady paycheck and benefits is a big risk, so putting your ducks in a row before you walk away is vital to your success.

Save an Emergency Fund

While you still have a steady income, save up an emergency fund with at least three to six months of living expenses. Everyone should do this regardless of employment, as you never know when an unexpected income loss could happen.

As a new small business owner, you should save more than the suggested level for people with a full-time job. Saving at least six months of expenses will ensure you don’t have to worry about income while building your new business.

Make Conservative Financial Projections

Before you create your budget, you’ll need to know how much you can afford to spend each month. That includes all of your business expenses, taxes, and personal expenses.

Create a spreadsheet in your favorite spreadsheet application (Google Sheets is a free option). On the top rows, list out your income sources. You’ll want to list out prior income by month or year, if any, and then use the trend to project future revenue for the coming months and years. Use conservative estimates. If your projection is too high, you can end up broke and out of money very quickly.

At the bottom of your income sources, add everything up using a SUM formula to see your total expected income by period looking forward.

Subtract New Business Expenses

Now that you know how much you are going to make, it is time to figure out how much your new business will cost. List out all business expenses on your spreadsheet below the revenue section.

Remember to include every single part of your business. Computers, subscriptions, office supplies, insurance, office or studio rentals, and anything else your business may need to operate should go on the list. Estimate high for your expenses when in doubt.

Don’t forget that as a self-employed individual you will need to get your own health insurance. You can look to Healthcare.gov to find an estimated cost for your needs in your state.

At the bottom of the section, use the SUM function to add up all of your expenses. Then on the next line, subtract your expenses from your revenue for a projected net profit. On the line below, estimate about 30% for taxes, then subtract that from your net profit to find your total net income.

List Out Your Monthly Recurring Costs

Now that you know how much money your business is going to earn, you know how much you have to live on. Because your fixed monthly expenses are not going to change, we’ll look at that next.

Create a new section on your spreadsheet either below your business section or on a new tab. List out all your monthly recurring expenses. Look at recent bank or credit card statements or use a budgeting app like Mint.com or Personal Capital to make sure you don’t miss anything.

Common recurring expenses include rent or mortgage payments, insurance, utilities, cell phone, home phone, internet, and TV. Remember that some utility bills will increase if you are going to start working at home.

Budget for Food, Gas, Clothing, and other Needs

No one wants to be hungry, so you must budget for food. However, you may be less inclined to eat out as a newly self-employed individual, so expect to spend a little less at restaurants and a little more on groceries. This will ultimately save you money. You will probably see gas and transportation costs go down as well if you are going to stop commuting.

List out everything that is a true need. Many people claim to have “needs” that are really wants, so look at each item carefully to decide if it deserves to be included in your budget. Things like alcoholic beverages, entertainment, and new gadgets clearly belong in the “wants” category.

Calculate Your Budget

Add up all of your recurring expenses and monthly needs to see how much money you need to get by each month. Does your projected business profit allow you to meet your minimum living costs?

If not, it may not be the right time to leave your day job. If you have a wide profit margin with room to spare, you are in good shape. Most people, however, will find themselves in a grey zone in the middle.

Go or No Go?

When I left my day job, I had a very narrow margin of error to scrape by. However, I had enough savings that I could focus on building my new business without earning a cent for a long period with no worries about money. Because I had already been earning as a side hustle, I wasn’t starting from zero and saw a path for growth in the immediate future after leaving the day job.

Before making a big product release, many companies have “go or no go” meetings where they decide if the time is right to pull the trigger. If your net income and budget indicate that it isn’t the right time to leave the day job, focus on savings and cutting your expenses to create the right opportunity.

Leaving a job for self-employment is a big deal. If you are well prepared and understand all of the financial implications going in, you will be on track for great success.

Eric Rosenberg

Eric Rosenberg

Eric Rosenberg is a personal finance expert. He received an MBA in Finance from the University of Denver in 2010. Since graduating he has been blogging about financial tips and tricks to help people understand money better. He is a debt master, insurance expert and currently writes for most of the top financial publications on the planet.

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