If I had a formula for bypassing trouble, I would not pass it round. Trouble creates a capacity to handle it. I don't embrace trouble; that's as bad as treating it as an enemy. But I do say meet it as a friend, for you'll see a lot of it and had better be on speaking terms with it.
~ Olliver Wendell Holmes
If your income is commission-based or you are self-employed, you may find budgeting to be more of a challenge. We have lived on various types of irregular income for the past 10 years or so. It's tempting to avoid budgeting altogether since you really don't know what your income might be from one month or year to the next. How are you supposed to plan anything?
While unpredictable income can be frustratingly difficult to plan for, it's critical that we take the time to budget. In fact, I've found that I've gotten a lot better at budgeting since our income became less certain. In many ways, keeping a conservative hand on the controls during some really good years has helped us weather the turbulence of the past 2 years.
Income Statement vs. Cash Flow Statement
Most people who receive a salary or have an otherwise regular income can basically use their income statement (a listing of income vs. expenses) as a basis for their budget. Those with irregular income, however, need to be a lot more concerned with cash flow. The cash flow statement details how and more importantly, when cash flows into and out of a business (in this case your household).
Whether you're income is 100% commission or self-employment revenue or is based on a salary of some sort plus commission or bonuses, you need to pay strict attention to cash flow and budgeting. In many ways, you're going to follow the same sound budgeting principles as everyone else, but in a sense, these rules are magnified for you. You still need to know where all of your money is going in order to make sure it's only going toward the things you value the most. It goes without saying that your budget must balance. Spending more than you take in is unsustainable and will deliver nasty consequences down the road.
10 Strategies for a Variable Income Budget
1. Average Income: This is the most common strategy I've read about. Here, you catalogue your expenses as you would for any other budget. To get your income figure, you estimate your net income for the year and divide it by 12. This works fine for people who can come up with a ballpark figure for their income. That's not always the case for those of us with truly irregular income. It pays to be conservative with your estimates and live well below your estimated means.
2. Issue a Pay Cheque to Yourself: This is a strategy that Lynnae at Being Frugal has written about. When you receive money from your employer or clients, place it in a savings account. Monthly or twice a month, transfer a specified amount to your chequing account (less any money allotted for savings) and use that to pay your bills. This will help you feel a little more “normal” and organized as you manage your finances. It may also keep you from spending every penny that comes your way. 😉
3. Gail's Budget System: By coincidence, Gail Vaz-Oxlade posted on this very topic yesterday. She had some great advice on what to do When Your Income Fluctuates. Her approach emphasizes breaking your spending into 4 groups: variable and fixed must-haves, and variable and fixed nice-to-haves. (Another great approach is Warren & Tyagi's Balanced Money Formula.)
4. Keep Your Expenses In Check: Since you have less control over what comes in, it's even more important to have control over what goes out. Don't let a few good months (or even years) lull you into thinking that you will continue to earn at that level forever. Bumps in the road can come when we least expect them and they can do a lot more damage if we don't have really good shock absorbers.
5. Magnify Your Emergency Fund: This is another area where budgeting irregular income means implementing something everyone should have, but kicking it up a notch. Everyone should have an emergency fund of at least $1000 or so for those unpredictable expenses. For someone with variable income, it should include at least 3- 6 months' living expenses.
This can be your single best shock absorber and it can relieve the stress of a low- (or no-) income month or two – or more. If you are stressed out about being able to buy groceries and make your mortgage payment, you're probably not going to be very effective at work. This can lead to a downward spiral and you don't want to go there.
6. Have an Emergency Plan: This is a plan that should be in writing or stored on your computer with your budget worksheets that details your monthly expenses and denotes the ones that get the axe first if your income took a hit. Perhaps you'll cancel your newspaper, downgrade your cable or cell phone package, or cut your dining out budget. It's easier to think about these things when you're not in crisis mode. If you're prepared ahead of time, all you have to do is break the glass and put your plan into action. (By the way, making sure you are adequately covered in terms of life and disability insurance is an absolute must.)
7. Avoid Debt: Again, this is good advice for everyone, but it's even more important for the income-challenged. Debt (contrary to what some seem to believe) constitutes a binding contract between a borrower and a lender. You don't want to make commitments that you're not sure you can keep. Keep your mortgage principle manageable, pay for your cars in cash, and never carry a credit card balance.
8. Establish an Alternate Income Stream: One way to offset the uncertainty of irregular income is to have a side income, even a very small one, from another source like a part time job, small business, or investment.
9. Keep Saving: This is an area where I have admittedly fallen down over the past year. 🙁 When our income was reduced, I cut back on savings along with a lot of other expenses, telling myself that we had put a lot away recently and could afford to take a year off. Wrong, wrong, wrong 2 Cents.
Starting today, I'm going to set up a monthly transfer from our chequing to our savings account. It's going to be a very small amount, but that doesn't matter. It's just there as a placeholder for a larger savings contribution in the future when things (hopefully) improve. The key is to establish a habit of saving and make sure that's one of the categories into which you place some money when cash flow is heavier.
10. Frequent Budget Check-Ups: Make a point of re-evaluating your situation at least monthly, or whenever your income or expenses change materially. If you have the potential to make a very profitable sale, start thinking about how you will allocate that income – and please remember that some of it should go to savings. That way, when the cheque arrives, you'll know exactly what to do with it and you'll hopefully avoid using it as a slush fund. (But don't be tempted to spend it before you actually have the cash on hand! ;))
Keep Your Balance Sheet Off Life Support
I don't want to imply that you're ill if you have a variable income, but it is sort of like having a manageable medical condition. If you follow the rules and take your budget's pulse often, you should be able to live a very comfortable, healthy life. If, however, you cheat by over-estimating your income, under-estimating your expenses, piling up debt, or failing to save, you may find your balance sheet on life support.
Do you have any other tips for people living on irregular income?