Heads up: this article includes some simple business math. No way around it and no reason to be scared. This information is how you put your business on a firm financial footing and develop the confidence to plan for the future.
It’s January and you’re sitting in a boat
It’s an old rowboat, sturdy and reliable, but it leaks (boats do that). My last dinghy – Tinker – was so sweet and shippy, but she needed bailing. Every now and again, you had to scoop out a few cans of water.
The months roll by and you’ve totally got the cans-of-water thing covered. Then…
BOOM! Four massive holes appear in your boat and water rushes in. You do everything in your power to plug them. Pillows, coats and the cat all get stuffed into the holes. But water is gushing in and the boat is sinking lower and lower.
Then it stops. With inches to spare. The cat stares viciously at you.
What the hell just happened?
Cash flow is what…
That’s just one of the topics on the table here. But let’s start with how much to pay yourself.
In the article Are you the boss from hell, I talked about how there is Boss You and Employee You. And I made the case that Employee You needs to stand up for your rights. But I’m going to add one caveat to that – how much you pay yourself.
Sticking with the boat metaphor, every business leaks money. For your business to survive, you need to have more revenue than expenses. When you’re starting out or sub $60k (or thereabouts), that’s your biggest challenge.
The solution is attracting enough clients, but until that client system is dialed in, you’re in a precarious situation. Regular clients = stability. No regular clients = instability.
That means you need to start your business in emergency mode.
Emergency mode means reducing your expenses to a bare minimum. The less you spend until you can secure regular clients, the longer you’ll have to figure that puzzle out. The biggest expense you can trim is your salary.
It’s not your money
The money your business makes is not your money. I’m not kidding. When you land a project for $10k, that’s not your money.
Your money is what your business can afford to pay you. This is when you need to be a tough boss over Employee You.
Pay yourself as little as possible until you have figured out how to bring in a reliable stream of quality clients and turn a profit on that work. Then you can think about a raise (or a decent salary to begin with). How much? Let’s work through a scenario…
How to pay yourself
I’m going to give you an example of when and how much to pay yourself once you have your client acquisition worked out. You can change the numbers on this depending on how risk-averse you are.
Context:
You’re a freelancer who’s been paying themselves $3k a month while you figured out the client stuff. Now you’ve got that sorted — and you want a pay raise. Here are your numbers…
Annual gross revenue: $70k (this is what flows into your coffers from client work)
Annual expenses (not including salary): $12k
Current salary: $36k
Money in business account: $10k
Lastly, you are risk-averse
You have $10k as a cushion in your business. That’s 2.5 months’ salary + expenses. Ideally, you want a 6-month cushion, so, if anything goes wrong, you have six month’s cover. It’s just a more comfortable cushion of time for problem-solving.
To make this equation work at your current salary? You need to have $24k in your business account. So, no pay raise yet.
If you want to pay yourself $5k a month, then you need to have $36k saved.
Now if you are less risk-averse and are happy with a 3-month cushion, you only need $18k saved.
Now, here’s the crucial bit….
Profits before a raise
If your business is reliably bringing in $6k a month and your expenses average at $1k, do not pay yourself $5k.
Your business needs to make a profit. At least 20%, but I recommend 40% – the more you budget for in the early stages, the better off you’ll be later (habits + accumulation = big win).
That profit is how you grow, how you survive economic shocks, and how you invest in yourself.
And that profit will fund your next pay raise. Here’s how…
Say you are on $5k a month and you have 6 months savings ($36k). If you can bring that to $42k, you can give yourself a bump to $6k.
Profits pay for that raise.
The final piece to consider
Now you have a framework for paying yourself, we need to get that money into your business.
If you want to be paid $6k a month, your expenses are $1k a month and you want to make $2k profit a month, then that’s $108k a year.
If you work 46 weeks a year and 25 hours a week on client work, you need to make $94 an hour on that work.
Want to pay yourself $10k a month?
You need to make a bare minimum of $136 an hour for your client work. (Assuming you don’t increase your profits from $2k a month, which is not a good idea.)
Is this making sense to you? When I was building Complete Breakthrough Freelancer last year and I started laying out all the formulas and frameworks I wanted to share, this one was the trickiest. It’s where I find people choke. They either don’t understand the numbers, or they don’t want to.
This little bit of financial literacy is worth the time it takes to understand it, I promise you that.
Paying yourself in the early days
Pay yourself as little as possible when you start out. You need to keep your expenses low to buy yourself the time to figure out the client-acquisition stuff.
Once that’s done, decide on how risk-averse you are. Are you happy with just two month’s expenses in the bank? Do you want more?
Run your business at a profit and use that profit to build that emergency fund.
Give yourself a pay raise when you have the emergency fund at the new pay level AND you can still generate a profit after the pay bump.
Tie your client rates to how much your business needs to pay you and generate a profit. And yes, this is 100% a valid strategy for pricing. There are other subtleties, sure, but this is almost a must if you don’t want to be cracking your head on the desk in frustration.
That’s it. Now, back to those damn leaks.
Cash flow is a torrent
Cash flow sounds gentle. A spring brook and babbling waters.
But it’s not. It’s evil.
It will lull you into a false sense of security with small monthly asks and then, WHAMOOOO!
Your accountant, your tax bill and your hosting charges (because you always take annual to save on those two months), plus whatever else you loaded up with that month last year, drop like a boulder on your business.
Good businesses go bust because of cash flow.
Be forewarned. Create a calendar of all your ongoing expenses. Have a total in each month.
Know when the big waves will hit.
That’s why we have that emergency fund. It’s why we need profits. It’s so easy to forget an upcoming expense, or bury your head in the sand about it. This way you don’t have to.
TL;DR
I know money talk is not the most exciting thing in the world. But you need to get the basics down or you could run yourself into trouble.
And having good money-management skills means you can make big decisions about your future with a lot more confidence.
Plus, do it right and you’ll always be in a position to walk away from your business for a few months if you ever need to. And we all need to at some time or another. You might as well do it on your terms.
This was originally sent as an issue of my weekly newsletter, Breakthrough Beat.
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