Explain how the base-pay method works and why it suits uneven income better than budgeting month by month.
If your income changes from month to month, stop budgeting from what came in and pay yourself a fixed salary instead. All your income goes into one account, and you pay yourself the same amount from it on the same day each month. This is the base-pay method, and it lets you plan your spending the way an employee plans around a payslip.
Most budgeting advice assumes the same amount of income arrives on the same day every month. When that doesn't happen, the usual methods become unstable. A common cycle goes like this: you set a budget in a good month and overspend the next. After a bad month you tighten up, then relax when a big invoice arrives, and the whole thing repeats. This cycle isn't a failure of discipline. The methods were designed for people on a payslip.
Take a freelance designer (an invented example) who earns 3,000 dollars in January, 9,000 in February, 2,500 in March and 6,000 in April. The designer budgets from whatever came in the previous month. On the strength of February's 9,000, they spend freely in March. By April they have almost nothing to live on until April's payment clears. Over the four months they earn 3,000 + 9,000 + 2,500 + 6,000 = 20,500 dollars, which is a reasonable income, yet it felt like a crisis twice. Budgeting from last month's income leads to overspending after a strong month and a shortfall in the month after it.
With the base-pay method, every client payment goes into a holding account. On a fixed date each month, you move your base pay, the salary you've chosen to pay yourself, from the holding account into your personal account. The holding account absorbs the swings in income, so your personal account doesn't see them. You plan all your personal spending around the fixed base pay figure.
The key decision is how big that salary should be. It's tempting to use your average month, but that's risky, because an average assumes good months will always arrive in time to cover the bad ones. Set base pay near what you earn in a lean month instead. Most months will then bring in more than your base pay, and the surplus builds up in the holding account. When a thin month comes, the holding account covers the shortfall and your salary still arrives on the usual date.
Before you work out base pay, take two things off the top. The first is business costs, such as software, equipment and travel to clients. The second is tax and MediSave. When you're self-employed, no one deducts tax and MediSave for you, and the bills arrive months after you earned the money. Money left sitting in your spending account feels like income and tends to get spent. So on the day each payment lands, move a fixed share of it into a separate tax and MediSave pot. Module 2 shows how to work out what that share should be.
That gives you three or four accounts. Client payments go into the holding account. A share of each payment moves from the holding account to the tax and MediSave pot. Base pay moves from the holding account to your personal account on a fixed date. You can add a fourth account for business costs if you like, which makes record keeping easier at tax time.
The holding account also shows you how the business is doing, more honestly than any single month can. If the balance keeps rising, you can consider raising your base pay. If it falls quarter after quarter, you have a pricing, volume or cost problem to fix, and you've spotted it while there is still money left to fix it. A budget based on last month's income can't show you this trend.
Your base pay must cover your essential spending. If your lean-month income can't support your essential spending, paying yourself a bigger salary won't solve it. The answer lies in your prices, the amount of work you take on, or your costs, and later modules deal with each of these directly.
Your own numbers are the only ones that count, and the next lesson uses them to set your first base pay figure. If you're just starting out, use your best estimate for each month. Your task: list your income for each of the last twelve months, circle the three lowest, and write their average at the top of the page.
Write down what you earned in each of the last twelve months, or your best guess, and circle the three lowest.
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