We’ve talked about budgeting and managing cash flow. This is hard enough with a fixed regular income.
In this post, we’re going to address those of you that have irregular incomes. Irregular income is income that is earned in variable amounts throughout the year - think commission, quarterly bonuses, or solo entrepreneurship.
Any of those types of income create complexity within your cash flow.
We'll go through:
- How to get a handle on this
- How to overcome short-term shortfalls within monthly expenditure
- And how make irregularity feel more regular.
In all things personal finance, usually the first step is figuring out what you have coming in and what you have going out. It’s no different here. First, we need to determine what you’re spending each month versus how much you’re taking home.
Take for example a person that has quarterly bonuses that make up a significant amount of their yearly income. They have a salary of $30,000 per year, and take home about $2,000 per month (after taxes are considered). This person expects to take home $15,000 from their quarterly bonus, and they spend around $4,250 per month.
This leaves them with a monthly deficit. What can we do about this?
Continuing the above example, until that bonus is received, this person has a monthly shortfall of $2,250. Without a plan, this can be a very stressful situation.
For this first quarter, let’s assume that we have enough cash to cover the shortfall in an emergency account or saved from prior bonuses. To avoid scrambling for cash monthly, let’s think about how we can automate this to pay ourselves something like a salary to cover the remaining deficit in the months going forward.
We want to consider setting up what’s called an ‘Owner’s Pay Account’. This account is usually a high yield savings account. We will channel the bonus to this account and then automate a payment back towards the primary checking account. This payment will serve as a ‘pseudo-salary’ and will cover the monthly deficit (the difference between this person’s traditional salary and their monthly expenses).
The leftover money can continue to be accrued in the pay account. Taking into consideration what we’ve previously discussed in our other budgeting and cash flow videos, we want to think of this as an emergency fund of sorts. Because this person’s income is primarily irregular, if they do not plan effectively, in quarters where the bonus is reduced or not received at all (this can be for any number of reasons), they need to have one or two quarters of expenses saved up in the pay account to continue to meet their monthly expenditure.
With that said, it can always be the case that the bonus or commission is much greater than they originally planned for. This where you can increase your monthly payouts to yourself from the pay account, or you can increase cash flow to other savings accounts or investments accounts.
Remember the goal is to normalize cash flow. Without this structure, lifestyle creep is extremely common in months and quarters where the bonuses/commissions are unusually high. In those down months, if they’ve built up that pay account, they can continue their lifestyle as normal without tapping additional savings or cutting expenses.
Every 3, 6, or 12 months revisit your income and expenses to see if you should be paying yourself more, less, or the same. Hopefully, your bonus/commission/business is growing, and you’ll be able to increase your pay to yourself.
On the other hand, if we’ve overextended and the pay account is dwindling, we may need to reassess lifestyle expenses.
This approach can provide a sense of stability to your irregular income. Essentially, you act as your own bank, supplementing your earnings during lean months while accumulating funds for future use during more lucrative months. I consider this strategy vital for achieving financial success. I've witnessed numerous business owners who exhaust their entire profits as soon as they receive them. Consequently, when they face lean months, they find it challenging to meet their financial goals or save because they lack the necessary funds. Don’t make the same mistakes!
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