Working for yourself: the money side

Self-employment removes an employer and everything the employer was quietly doing, most of which people only notice when it is missing.

What the employer was doing

The list is longer than expected.

Deducting tax and social contributions before you saw the money.

Contributing to a pension, frequently with a match.

Providing sick pay.

Providing paid holiday.

Providing parental leave and pay.

Providing insurance, sometimes including life cover and income protection.

Absorbing the cost of equipment, software, training and premises.

Smoothing income into a monthly payment.

And carrying the risk of clients not paying.

All of which now falls to you, and pricing that does not account for it produces an effective rate far below the equivalent salary.

Pricing that accounts for it

The calculation.

Start from the annual income you need.

Add tax and social contributions.

Add pension contributions.

Add an allowance for holiday, sickness and quiet periods — which means dividing by billable days rather than by working days.

Add business costs: equipment, software, insurance, accountancy, training, travel and premises.

Add unbillable time: admin, invoicing, marketing, client acquisition and professional development, which is frequently a substantial share of the working week.

Divide by realistically billable hours.

The resulting hourly or daily rate is generally considerably higher than people expect, and undercharging is the most common reason self-employment fails financially.

Tax

Where the largest problems occur.

Register with the tax authority within the required timeframe, since penalties for late registration are real.

Set aside a proportion of every payment received in a separate account, on the day it arrives.

Keep records of income and allowable expenses, since expenses reduce the bill and cannot be claimed without evidence.

Understand deadlines for filing and payment, and any payment-on-account system where the first bill includes a payment towards the next year — which catches out almost everyone in their second year.

Understand registration thresholds for sales taxes, which vary and which have consequences for pricing.

And consider whether a company structure is appropriate, which depends on income level and jurisdiction and which has ongoing compliance costs.

Cash flow

Which kills more small businesses than lack of profit.

Invoice promptly, since the delay before invoicing is added to the delay before payment.

State payment terms clearly and chase from the day they are exceeded.

Take deposits and stage payments for larger work.

Charge interest on late payment where the law permits, which exists in many jurisdictions and is rarely used.

Keep a cash buffer covering several months, since the gap between doing work and being paid can be long.

Diversify clients, since dependence on one is a serious risk.

And check clients' payment history before taking on large work.

Protection

What to replace.

Income protection insurance, which addresses the loss of sick pay and which is the product most closely matched to the actual risk.

Critical illness cover.

Life insurance with dependants.

Professional indemnity insurance, which some professions require.

Public liability insurance.

Equipment insurance.

And a larger emergency fund than an employee would need, commonly six months or more of essential expenditure.

Pension

The most commonly neglected item.

Without an employer, nobody is contributing on your behalf and nobody is enrolling you.

Self-employed pension participation is markedly lower than among employees in most countries, which produces a substantial retirement gap.

Contributions generally receive tax relief, which reduces the effective cost.

Setting up an automatic monthly contribution, however small, at the point of starting is far easier than beginning years later.

And a proportion of every large payment directed to it captures good months.

Record keeping

Which becomes a problem if left.

Separate business and personal accounts, which is the single most useful structural step.

Accounting software or a simple spreadsheet maintained monthly rather than annually.

Receipts kept in whatever form your jurisdiction accepts, which is increasingly digital.

Records retained for the required period.

And an accountant for anything beyond the simplest situation, whose fee is frequently exceeded by the tax they save and the errors they prevent.

The transition

Practical advice for starting.

Build a client base before leaving employment where possible, subject to your contract.

Have several months of expenses saved before starting.

Expect the first year to be harder financially than projected.

Set up the tax account, the pension and the separate bank account in the first month rather than the first year.

Check what benefits or support exist for new businesses locally, which frequently includes free advice and sometimes grants.

And understand that income may affect any benefits you receive, which needs declaring.

General information only, not financial or tax advice. Rules vary enormously by country — consult a qualified accountant before starting.