Executive Summary

  • What you Bill isn't what you Earn personally
  • As a Freelancer, you still have to allow for taxes, rainy days and growth investment when calculating your personal drawings
  • As a rule-of-thumb, assume your personal spending money is circa 35% of what you invoice/bill (in the UK)
  • As you grow past about £150,000 of revenue, this gets more complicated, exciting and personally profitable. You will need advice from a qualified accountant (plus probably a Business Mentor)

Introduction

I've worked with hundreds of Freelancers, literally, over the last 20 years. Whether they called themselves a "small business owner", a "company of one" or a "Freelancer", there was always a common problem. Their billings are clearly not their personal earnings. So, the question is:

As a Freelancer, how do you account for taxes, rainy day funds and growth capital so you don't over-draw from your business?

To address this question, I want to give you a simple, clear illustration of how to think about your billings/invoicing so you don't "over-draw" on your business.

Let's start with some Freelancer assumptions

Some basic assumptions as a Freelancer or "Company of one":

  • Assume you invoiced your UK clients £5,000 at the end of December 2019
  • You are a Ltd company and you are VAT registered (in the UK)
  • You are personally a "higher rate" tax payer, i.e. your annual Gross Income is between £50k and £150k
  • You pay yourself via a combination of salary and dividends
  • You want to grow your "company of one" over the coming years

This is how you make sure you don't over-draw from your Freelancer business:

Tip 1: You will need to have a minimum of TWO business bank accounts set up PLUS TWO personal bank accounts to make this work (which is really easy to do):

  • One Trading_Business_Bank_Account for day-to-day trading
  • One Tax_Business_Bank_Account for paying your future company "Taxes"
  • One Personal_Bank_Account for living
  • One Personal_Tax_Bank_Account for paying your future personal Dividend Taxes

Now, let's get started and take it step by step:

  • Step 1: You collect invoice receipts of £6,000 (i.e. £5,000 revenue + £1,000 VAT assuming 20% UK rate). This is deposited into your Trading_Business_Bank_Account.
  • Step 2: You transfer the VAT of £1,000 into your "Tax_Business_Bank_Account" to pay your future VAT liability.
  • Step 3: Next, you subtract any tax-deductible-expenses/salary from the £5,000 of revenue. Let's say that's £1,000 in this example.
  • Step 4: So you now have £4,000 of Taxable-Profits.
  • Step 5: Now, calculate your Corporation Tax (currently 19% in the UK) which in this case is £760.
  • Step 5: Then, transfer £760 into your "Tax_Business_Bank_Account". This is to pay for your future Corporation Tax liability.
  • Step 6: You are now left with a surplus of £3,240.
  • Step 7: Now, allocate 20% of this surplus for "rainy days" and "Growth investment". In our case, this is £648.
  • Step 8: You are now left with a maximum of £2,592 which you can distribute as Dividends potentially.
  • Step 9: Next, distribute up to £2,592 as Dividends to your Personal_Bank_Account.
  • Step 10: Now, transfer £829 (32% of £2,592) to your Personal_Tax_Bank_Account to pay your Dividend Tax in the future.
  • Step 11: Finally, you can relax, you now have £1,763 for personal spending. Or, put another way, 35% of what you invoiced back in Step 1!

Tip 2: Assume your personal money to spend is circa 35% of what you invoice as a small business or freelancer.

Conclusions

  • Being a Freelancer isn't an easy route to riches
  • Don't fool yourself when you see the revenue coming in. It's not all your money!
  • If you want to be rich, build a big company or become a very successful investor

IMPORTANT NOTES:

  1. The same principles apply no matter where you are in the world, it's just the tax calculations that will change.
  2. If you don't believe me, look at ROBERT KIYOSAKI's famous video with over 2.7m views https://www.youtube.com/watch?v=s7nO19BKNDA
  3. I am NOT a Tax Accountant and I take NO LIABILITY for anyone that uses any of the above to calculate their taxes. You MUST check with your Accountant on any of the above as it relates to your personal circumstances