1236662_money_heap Getting by on an irregular income is all about managing cash flow. When the cash flows in, you need to manage it in a way that there is enough to cover the months when the cash isn’t flowing in so freely.

When I worked in an accounting firm, I often worked with farmers on their cash flow budgets. If anyone has irregular income, it’s a farmer. Keeping a cash flow budget is one way to keep track of whether you are able to meet current and future expenses regardless of whether your income is stable or fluctuates wildly.

A cash flow budget doesn’t track income and expenses per se, but all cash inflows and cash outflows. It includes things like mortgage, loan and credit card repayments and regular investments.

The more accurate your cash flow budget, the more useful a tool it will be when managing your finances. You can find a tutorial on creating a cash flow budget in excel here.

Start with your expenses

Start your budget by filling in your expenses – this gives you an idea of how much you need to be earning to cover the cost of every day living.

Prioritise your expenses into those that must be paid every month and discretionary expenses that can be cut if your income won’t cover them.

Work out the timing of your expenses. If you pay your car registration once a year, which month do you pay it? If your electricity is quarterly, what months does it fall due? Rather than guessing expenses and averaging them out over the year, put them into your budget on the month that they fall due. This way you know which months you’re going to need extra cash and how long you’ve got to save up for these expenses.

Use an envelope type system to save up for upcoming expenses. Put funds away for each expense in your budget in the good months so that you are able to cover them even if they fall due in the lean months.

Add in your predicted income

There are several ways that you can budget your predicted income:

  • If you have had irregular income in the past, base this year’s income on last year’s adjusting it for any known changes
  • If your work is seasonal, then you will have some idea which months will bring in higher income than others.
  • You could predict your income as per the amount of work that you reasonably expect to generate and the terms of trade that you intend to offer (ie, 30 day accounts etc). Be conservative in this estimation, it’s better to underestimate than to overestimate your income. If you’re new to irregular income, then maybe ask others in the same line of work what they earned in their first year and again give a conservative estimate.
  • Your cash flow budget will work better for you if you can predict how much income you expect in which month. That will give you an indication in advance which months will be lean. However, if this is not possible take last year’s income and average it out over the 12 months
  • If you get a base salary plus a commission, you could budget according to the base salary and consider any commission a bonus.
  • As the year progresses you may get a better indication of you income patterns. Adjust your budget accordingly.

How this works

Below is an example of a cash flow budget with income and expenses (click to enlarge).

irregularcashflowThe bottom line shows the net cash flow per month (inflows (income) less outflows(expenses and other payments)). The cash flow is not only affected by irregular income, but also irregular expenses. As you can see there are both positive and negative cash flow months. This is reflected in the following graph:

monthlycashflowchart The graph clearly shows which months will be the ones when you need to save and which ones will be the lean months when you need to dip into those savings.

The important figure in the spreadsheet though isn’t the monthly cash flow amounts but the total cash flow for the year. You want this total amount to break even or be positive to be assured that you can cover all expenses throughout the year despite the irregular income.

irregularcashflow2

What happens if this total yearly cash flow is negative? You could look at getting more work or adjusting your expenses down (realistically), but before doing that another factor affecting whether you can meet your yearly expenses is the amount of savings you already have at the beginning of the year. Consider the following budget:

irregularcashflowwithbankbalanceThe cash flow budget begins with the opening bank balance at the beginning of the year. This amount includes the balances of all savings accounts. At the bottom of the cash flow is the closing balance as at the end of the month (Opening balance + net cash flow = closing balance). Of course, the closing balance for the month is the opening balance for the next. By including your running bank balance in your cash flow budget, it reveals whether you have enough funds to meet your monthly expenses.

In the example above, the total yearly cash flow is negative (we’re spending more than we earn for the year), but the savings from the previous year covers the overall negative cash flow (and of course, the difference in the bank balance at the beginning of year to that at the end of the year is the net cash flow for the year, in this case -$759.27). A total negative yearly cash flow is obviously something that cannot be sustained year after year (unless you have a lot of savings or go deeply into debt).

May is a problematic month as there are not enough funds in savings to cover expenses. This is where prioritising your expenses becomes important. In May, discretionary expenses will need to be cut to stay out of overdraft or to avoid using the credit card.

Update your budget regularly

You want to create a living cash flow that you update regularly. Updating your budget by putting in your actual income and expenses each month will give you a much more accurate picture of whether you will be able to adequately meet future expenses, and will allow your budgets to be more accurate in future years.

At the end of each month adjust the budget to accurately reflect month’s actual income and expenses. Notice how these changes affect the overall cash flow. Do you still have a positive total yearly cash flow? Does your savings cover any deficit?

Also, adjust your budget to reflect changes in your predicted income or expenses. Your spending patterns in August may not reflect your predictions made in January. Life changes. The more you adjust your budget to accurately reflect this, the more useful a tool it becomes.

More tips on budgeting with an irregular income

The most important tool when budgeting for irregular income is your savings account. Without funds put aside to tide you over in the lean months, you will be relying on debt to pay the bills. How much you should aim to put aside in your slush fund will depend on your circumstances but 2 – 3 months worth of expenses should be enough of a buffer to give you peace of mind. Your slush fund is there to even out the peaks and troughs in your income.

Avoid debt if you can as this will make coping with an the troughs of an irregular income harder.

Don’t forget to build an emergency fund on top of your slush fund for unexpected expenses.

Have a plan for the income that you earn beyond your slush fund amount. This extra cash might go to debt repayment, home deposit, holiday or splurges.

Have a set sanity allowance both for the good months and the bad so that the temptation to splurge isn’t as strong when cash comes in.

Being Frugal suggests having a high interest savings account into which your income is deposited and from which you pay yourself a set salary monthly or weekly, giving yourself the a ‘regular income’. For more details, check out the article here.

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