How to budget your way to healthy cash flow if you’re self employed

Businesses usually fail because they run out of cash and can’t pay their bills when required. Although non-payment and late payment remain a big problem for many small UK businesses, one that causes serious cash flow issues, others get into difficulties because they live beyond their means.

Letting your spending exceed your income is a dangerous mistake that can soon prove fatal. However, budgeting offers a reliable solution to businesses of all sizes, new and established, because it enables you to control your spending and costs.

What is budgeting?

Budgeting is something many of us already do in our personal lives. It’s no different in business. Budgeting simply means working out how much you can afford to spend, deciding where or how you should spend it and then controlling your spending so that you live within your means and keep your cash flow healthy, providing that you make enough sales and get paid on time (if you grant credit).

Spending too much in one area of your business might seem like a relatively minor thing. But if you do that throughout your business it can create a far bigger cash flow problem. And if you don’t set and work with spending budgets, you may not realise that you’re spending too much until it’s too late.

How to set budgets

You need to start by working out your likely income for each month for the year ahead. Your income may fluctuate at different times of the year, which is true for many businesses. Once you have a reliable/realistic idea of how much your sole trader business is likely to bring in, take away the amount that you need to earn to cover your living costs (don’t forget, you’ll also pay tax on your income). That will give you an idea of your spending budget, although you may decide to increase or decrease it.

Example 1

● If you expect your self-employed income for the year to be £36,000 (£3,000 a month), you’ll pay about £7,000 in Income Tax and National Insurance contributions, which leaves £29,000.
● If you want/need to earn £24,000, you have a yearly budget of roughly £5,000 (£420 a month) to operate your business. If that’s not enough, you’ll have to increase your business income or settle for less take-home.

Example 2

● If you expect your self-employed income for the year to be £52,000 (£4,300 a month), and need a budget of £1,500 a month to run your business, which you claim as allowable expenses, you’ll pay about £7,700 in Income Tax and £3,600 in National Insurance contributions, which leaves £39,000 for you in take-home (2023/24 tax year for approximate figures given).

Setting monthly budgets

Once you know how much you can afford to spend to run your business over the course of a year, you can create monthly budgets for all key cost areas of your business (eg premises, materials, travel, marketing, finance, sub-contractors/freelancers, etc).

You may have to adjust these for different months, for example, if you know you’ll be traveling less in certain months of the year or you can spend less or nothing on marketing because you’re less likely to sell during certain months. Always seek to allocate budget to areas where it will bring the best results and enables you to meet your business objectives/targets.

Working with your monthly budgets

● You need to realise the importance of budgeting and working with budgets. Budgeting forces you to think carefully about how your business spends money, which can ensure that you don’t waste money or put your business at risk by overspending.
● Budgeting also encourages you to gauge the value for money that you get for every pound you spend running your business.
● Get into the habit of looking at your accounts each month to carefully assess your actual business costs against your set monthly budgets in key areas.
● Avoid overspending wherever possible. If you overspend in one area, look for savings in others.
● If you’re spending less against a set budget, reduce your monthly budget in that area and consider recommitting funds to other areas.
● If your actual sales are less than expected during one month, you may need to reduce your monthly budget for the following month(s), so that your sole trader business is not spending at an unsustainable level.
● Once you get to the end of the year, reassess your budgets and reduce or increase them where necessary, obviously, remaining within your overall budget for the year ahead.

Setting budgets can be tricky for both variable and (so-called) fixed costs, because, in truth, both can change over the course of a year. If you lack experience, you may be able to improve your budget-setting and budget-management skills, but you should never forget how important budgeting is to successful cash flow control. If you don’t work with budgets, you have no reliable idea of how much your sole trader business can afford to spend, which is highly risky, especially in times like these where prices have risen significantly, very quickly, in most areas.

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