Dealing with uncertainty: budgeting tips for contractors

In uncertain times, how can contractors make sure that their finances are future-proofed?

Being in control of your budgeting can provide many of the answers; here are some key actions to help keep your finances on track.

Have six months’ cash in your account

“If you’re new to contracting, work on the assumption that it might take between one and six months for you to win your first contract,” says Dave Chaplin, CEO of contracting authority Contractor Calculator and IR35 Shield. “This might seem like a long time, but it’s wise to build up a fund of six months’ living expenses to cope with the unexpected.”

The good news, Chaplin adds, is that you’ll likely earn more than you would have as a permanent employee. “So building this fund may not take quite as long as you think.”

Calculate your monthly outgoings

“Be honest with yourself,” says Chaplin, “and make allowances for the luxuries you enjoy over and above the basics like housing costs, utilities, food, clothing and so on.”

Depending on your role as a contractor, you may need to travel; costs that in the past would have been paid by your employer may now need to be from your own pocket. “Hotels, subsistence and travel costs need to be allowed for.”

Build a cash reserve for your tax bill

“In the first year, what floors many contractors is having to pay HMRC on account,” says Rebecca Seeley Harris, employment status and IR35 expert at Re: Legal Consulting. “Whilst you may be ready for a £5,000 tax bill, for example, you also need to pay half as much again on account for next year.”

Think about additional fees

“You may be able to do your own basic bookkeeping,” says Seeley Harris. “But you are likely to need an accountant, and you will definitely need one if you are establishing yourself as a limited company.”

There are other outgoings that you won’t have thought about as an employee. “The bookkeeping software might be £300 a year, and you may need to pay a fee to the Information Commissioner’s Office (ICO) for data registration,” says Seeley Harris. “Not huge amounts but they all build up, especially in the first year.”

Stay up to date

“Working as a contractor will usually mean you will no longer pay most of your tax through PAYE,” says Chris James, director of accounting services at JSA Group and chairman of the Freelancer and Contractor Services Association (FCSA).

You may be able to do your own basic bookkeeping but you are likely to need an accountant, and you will definitely need one if you are establishing yourself as a limited company

Rebecca Seeley Harris
Employment status and IR35 expert, Re: Legal Consulting

Be disciplined in your record-keeping, he adds: “You’ll experience new timing issues around the payment of various taxes.” This includes corporation tax if you’re a limited company, “usually paid nine months after the company year end”, and VAT, normally paid every three months when your turnover is greater than £85,000 a year.

Avoid nasty surprises

With the above in mind, “use a ‘live’ (ie cloud-based) accounting system that your accountant can look at to help you on an ongoing basis”, James says. “If this is too 21st century for you then at least keep records right up to date so that if someone else needs to prepare a forecast of your future tax liabilities, this isn’t held up by you having to do basic record-keeping. Good online systems will automatically forecast your future liabilities.”

Ensure you bill and collect promptly…

Problems with cash flow can cause up to 29% of start-ups to fail. “One of the biggest challenges for small businesses is getting paid on time,” James says, “so make sure you bill as soon as you’re allowed, and try not to get taken advantage of by large customers who aren’t in your situation – you may need to get paid to pay your bills at home.”

… but allow for timings of payment

“You might finish work with a month’s money, and when you get a contract you could be paid weekly,” says Chaplin. “This will certainly help cash flow. But it might not always go so smoothly and having savings can help tide you over.” If you are paid monthly on your first contract, Chaplin adds, “remember you’ll have to work the 30 days and then invoice. Most agents pay within five days of the invoice, and shouldn’t drag it out for 30 days”.

Consider income protection

“As soon as you stop working, you stop earning,” says Seeley Harris. “Income protection can be costly, but you need to think about what would happen if a client defaulted on a large payment, or if you were ill.”

If the worst happens, James adds, “and you were incapacitated or even lost your life, your family would find it surprisingly difficult (and slow, and expensive) to get their hands on the money they need. For this reason, it’s worth considering setting up powers of attorney when you establish a business, and refreshing your will”.

Understand IR35

April’s IR35 changes will have a big impact on contractors working for large companies. “Look for opportunities outside IR35,” says Chaplin, “and if you are considering an inside IR35 engagement under the new legislation, understand the financial impact of the new rules on your income.”

You can use an off-payroll calculator to assess this. Chaplin adds: “Including how much you would need to increase your rate by, for an ‘inside IR35’ engagement to be net income-neutral.”

Think long term

When you work for yourself, you have to provide things that might previously have been benefits – pension payments, employment rights like sick pay, and perhaps private healthcare. “Pension contributions are a useful and tax-efficient way to save,” says James. “But once money is in a pension, it’s very hard to get out in an emergency.” Speak to a financial adviser about what’s possible, and how much things will cost.

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