The Cure for Income Irregularity

How To

photo: stuartpilbrow

Are you troubled by occasional irregularity?

Don’t worry, I’m talking about your income. When you have an irregular source of income, it can be like manic depression: one month, you get a couple of big checks, and you’re rich! Next month, where did the money go?

You might have irregular income for a variety of reasons:

* Temp work

* Commissions or bonuses

* Independent contracting or freelancing

* Advertising revenue

* eBay, Etsy, or other online sales

Believe me, I know about this firsthand. In the past couple of years, my income in a given month has ranged from $0 to $18,000. (This is not an exaggeration, although the high end of the spectrum was a big-time outlier.) I’d be happy to tell you what a typical month looks like…except that I don’t have typical months. You know the saying “past performance is no indication of future returns?” I think they were talking about me. Looking ahead, I know what the next couple of months look like, but beyond that? Could be the goose that lays the golden eggs–or just a big goose egg.

The most common way people deal with zig-zag income is to try to match checks to expenses. As in, “We have a check for $1200 coming in; that can cover the repair on the water heater.” This is a good way to end up in debt.

Even though this type of irregular income is common, most personal finance books assume you put on a suit, go to an office, and take home a boringly regular paycheck like it’s 1955 and you work for IBM. My friends Danny and Shauna Ahern, a chef and a food writer, are more typical of people I know today: he gets a fairly predictable paycheck, but her income, from assignments and ad revenue, is all over the place. This year is going pretty well for them, but they have no idea how well.

“When you have a big check coming in, it’s like, woo! We have money!” says Shauna. “We have to be penurious for weeks; then the money comes in and we can afford a massage. Then we’re back to where we were.”

Furthermore, the landlord, the electric company, and the supermarket prefer to be paid on time. Just depositing all my income into a checking account and spending what’s there doesn’t work. It might work this month, but what if this turns out to be a golden-egg sort of month and I overspend? What happens next month? How do I know how much money I can spend and save when I don’t know what my income will be in July?

I need to put my income through some sort of industrial smoothing machine. In other words, I need to understand my cash flow. Yes, this is going to involve some math. But we’re not talking linear algebra here. It’s addition and division. Let me show you how it works. If, like me, you’re in a couple where one partner is salaried and the other is paid irregularly, I’ll show you how to deal with that, too.

Let’s cook those books

 Okay, pull up Excel, Google Spreadsheets, or a Moleskine. It’s spreadsheet time.

First, list off your expected income, as far out as you know it. In my case, I list everything for which I’ve billed clients and they haven’t paid yet. To this list, add your current checking balance. The total represents your cash. For me, this number currently adds up to $9,500.

What if you think you’re going to be paid for something but you’re not sure? You can discount it: write down half the amount, or three-quarters. Because I work on assignment, I’m generally able to put something on the list at least a month before I receive the check.

Next, turn to your list of monthly expenses, which should include your fixed expenses, your spending money, and your savings. For me, this number is $4,972. (We don’t spend that much every month; a big chunk goes to savings and self-employment taxes.)

Now–work with me here–divide your cash by your expenses. I get 1.9, which means that in about two months, unless I invoice more jobs, I’m out of money.

That’s no good. However, I’m omitting something important: my wife’s paycheck. (Incidentally, because she works for the government, her salary is a matter of public record. Puts the whole Facebook privacy thing in perspective, doesn’t it?)

So I only need to look at the portion of our expenses covered by my income. That means I subtract my wife’s monthly paycheck from our monthly expenses. I get $4,972 – $4,000 = $972.

That means my share of the monthly expenses is $972. Divide $9,500 by $972, and you get 11.1. Great–I could bill nothing new for the next 11.1 months, and we’re fine, as long as my wife doesn’t lose her job.

How many months of cash flow is enough? I like to keep it to greater than six months. If it drops below that, I need to scrounge up some new assignments–or reduce some expenses.

The final ingredient: “pay yourself as if you’re an employee,” as Get Rich Slowly’s J.D. Roth puts it. I do this by transferring a weekly allowance from one account to another.

Congratulations: you’ve just smoothed out your finances with the Steamroller of Truth.

A couple of weeks ago, Shauna and Danny did their calculations and set up a second checking account to receive their weekly spending money. The result, according to Shauna? “This is the first time we haven’t been worried about money in two years.”

The downside

This system works well for me. But you might want to consider:

* If someone takes a long time to pay you, you can run out of cash even when your cash flow looks fine. I keep an eye on my checking balance and sometimes put off some savings until the following month when necessary.

* If your income is only a little irregular–sometimes you get a bonus, say, on top of base pay–what I do is probably overkill.

* My wife’s income is enough to cover our fixed expenses, so we’ve tried dedicating my pay to savings. The predictable result: less savings, and little incentive for me (a natural born couch potato) to drum up business.

* If your income is not only irregular but unpredictable, and you don’t know what’s going to happen even next month, you’re probably better off averaging past income rather than calculating cash flow. J.D. Roth has instructions for doing that.

Finally, if you get an adrenaline rush from riding the bipolar coaster of irregular income, this will ruin it for you. That’s the point.

Matthew Amster-Burton, author of the book Hungry Monkey, writes on food and finance from his home in Seattle.

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