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I apologize in advance as this article is longer than usual. But the topic is very important! We often get asked questions about how you can possibly budget with irregular income such as bonuses, commissions, or self-employment income.....
Receiving income from self-employment, commissions or other irregular sources can be complicated because the income is unpredictable and varies significantly from month to month. Most people in this position feel it is impossible to plan ahead and budget. So many make the mistake of spending whatever money they earn, as they earn it. They set their lifestyles according to good income months. Then tougher times come along and they starve during these lean months, allowing credit card balances to mount, while hoping and praying for a good month to come bail them out. This is not a good solution.
A Great Solution
There is a much simpler, less-stressful way to handle this type of income. You must consider yourself a “small-business owner”. This means you essentially wear two different hats: employee and employer. As the employee, you need to determine the lowest reasonable salary your family can live on based upon your budget. As the employer, you pay yourself exactly that set “salary”, whether business is booming or struggling. Obviously the “salary” must be reasonable for the work you do. In other words, if you estimate your yearly income to be $48,000 ($4,000/month); don’t setup your monthly “salary” to be $6,000 per month because that is what your budget needs. In this case, you need to revisit your budget to balance things out so you can take a realistic “salary”.
Now we’ll review the technique. The key is to work toward funding a savings reserve from which you can draw the steady “salary” income you established above; regardless of whether business profits are plentiful or lean. For example, assume you are able to save $4,000 for this reserve, and your budget requires you draw $3,000 income per month. If you have a month when you earn $2,000, you will need to withdraw $1,000 from your savings reserve to meet that $3,000 draw. Then if you earn $5,000 the next month, still draw only the $3,000 and deposit the other $2,000 into your savings reserve. You are essentially using this savings reserve as a buffer to smooth out your income. So no matter what comes in during any given month, pay yourself only the established salary amount. Allow any overage to sit in reserve, since it might be needed to cover your salary draw during leaner months. Now you know exactly how much your income will be each month so you can budget.
The biggest challenge for those with unpredictable incomes is not to spend everything they earn during higher income months, only to resort to credit cards during lower income months. Using the “draw” method will help smooth out that income. It all depends on your willingness to be disciplined and to exercise restraint when one month it appears your ship has come in. Don’t believe it. Stick to your plan.
If at some point your savings reserve has a plentiful cushion (6+ months of “salary”), take an additional draw to fund other goals such as paying down debt or saving for your kids’ education.
If you read this article and found yourself saying “wow, that’s a good idea!”…then please implement the idea and share it with a friend! And feel free to call or email us if you have questions on how to handle your finances with irregular income…we’re here to help!!