Tax planning season is upon us. And many creatives may be worrying about their tax obligations, and whether or not they’ll get a refund, or get hit with a big tax bill. The very moment you step out as a professional creative entrepreneur you have, minimally, introduced a more complicated tax situation for yourself. Adequately saving for taxes is critical, but taxes aren’t the only thing your business needs to be saving for. Failing to set aside sufficient revenue for future expenses is one of the biggest failures in small businesses.
Adequately Saving For Taxes
But first taxes. As a self-employed individual, you will need to not only pay your normal income tax, but also self-employment tax which comes out to about 15% of your net income. So when you get paid by your client, if you’re not setting aside a proper proportion of that revenue for taxes, you’ll end up with a whopper of a tax bill. Exactly how much you should set aside is a question for your accountant. But a safe rule of thumb would be somewhere between 20-30% of your revenue. And keep in mind, that while self-employment taxes need to be paid via quarterly estimated tax payments, those quarterly payments are not necessarily what you may actually owe. Your quarterly payment is based on your previous year’s revenue. So if you’re having a good year, and you’re only paying estimated taxes, you’ll have a lot more to pay come tax time.
And so you need to set aside whatever percentage you choose whenever you get paid. And I strongly suggest moving that amount into a savings account and keeping track of your savings allocations in a spreadsheet.
Other Important Savings Categories
But this brings us to the bigger topic of this article—the critical importance of business savings in general. Any financial advisor will tell you to maintain at least three months of operating expenses, in savings, as a buffer against downturns. I’d actually suggest six months. I’ve been in business through the dot.com bubble burst of 2000, 9/11, and the banking crisis of 2008. Three months of savings would not have cut it in those times. You never know when a serious downturn might occur.
Certain but Unpredictable Savings Categories
In addition to a general buffer, it’s also important to set aside savings for known future expenses, that are certain, but infrequent or occasional enough to be overlooked. Not planning for occasional expenses such as equipment replacements, annual expenses, and transitional costs (like moving to a new office space) is one of the biggest strains on small businesses.
Sooner or later your computer is going to fail. Are you setting aside a little bit of money each month, so that when that day arrives you’ll have the cash on hand to replace it? Or do you assume you’ll just put it on a credit card when the time comes? Do you set aside funds for professional development? Eventually you’re going to want to take a class, or attend a conference, or some other activity to build your professional skills. Do those expenses end up on a credit card too? Other expenses, such as accountant’s fees, come only once a year. Legal fees to review important contracts may be rare, but it’s important to have some funds for such times when they’re needed. Additional unpredictable expenses include annual liability insurance payments and occasional marketing expenses (such as conference expenses).
Since you know that these expenses are going to be incurred at some point, you ought to be including them in your monthly budget, and transferring those funds out of your checking account and into a savings account every month. Then, break those transfers into columns on a spreadsheet to keep track of how much you’ve saved for taxes, professional services, marketing and so forth. Then, when your account’s bill comes due, you can transfer that amount back from savings into checking to pay the bill.
A Crisis Isn’t a Crisis if You Should Have Seen it Coming
Many freelancers and creative entrepreneurs who fail to realistically budget for all of the necessary, long-term expenses of running a business eventually run into a cash flow crisis. But, when you should have known, and saved for such expenses, they aren’t true crises, they’re simply the result of failure to plan and save for predictable expenses.
Managing your cash flow, alongside a realistic expense forecast, is a key business discipline for any entrepreneur. Creative entrepreneurs are no exception. If you’d like some help getting setup up with a better budgeting and planning tool, you can access a copy of a cash flow spreadsheet from the resources section of my website. There are also a couple of videos on how to update and maintain a cash flow among my training videos.
I hope you’ve set aside enough for taxes this year, but you should also plan on setting aside funds for other expenses that are perhaps not as certain as death and taxes, but all come due eventually.