Preparing financially for self-employment

Leaping from a full-time job to becoming self-employed is exciting and can be very rewarding, but it’s important to be financially prepared.

Moving from a regular wage to working for yourself with an irregular income means you need to ensure you have enough money to live on.

You should have enough savings to see you through the early stages of self-employment and sufficiently budget your finances as your business progresses.

This guide outlines how to do it successfully.

Understanding the financial shift

When you have a salaried job, your employer is responsible for calculating your tax and National Insurance liabilities and deducting them from your wages through PAYE.

As a self-employed individual, you need to work out how much you owe in tax and file an annual Self Assessment tax return with HM Revenue & Customs (HMRC).

Employees typically pay their taxes monthly through PAYE, whereas the self-employed typically pay taxes twice a year.

Payment of a Self-Assessment tax bill is due by 31 January following the end of the tax year.

If you are self-employed, you must usually also make advance payments towards your next tax bill.

These ‘payments on account’ are usually due on 31 January and 31 July.

These arrangements mean you must ensure you set enough funds aside to pay your taxes by the deadlines.

Failure to do so could result in penalties and interest.

In self-employment, your monthly income will likely be more irregular than you’re used to, so you need to factor this in with funds in place before making the leap into working for yourself.

Initial business expenses

Typical start-up costs include:

• accountancy and legal fees – money spent on professional services such as an accountant and solicitor for activities such as business plan advice and registering as a limited company if you decide to go down that route
• business registration – this includes fees for Companies House registration, setting up a registered office, and licences
• marketing – this is money spent on activities such as creating a website, logo design, printed marketing materials, social media assets, and market research
• office, property, and equipment – costs such as rent, using co-working spaces, stationery, broadband, business rates, energy, insurance, laptops, and furniture.

Before becoming self-employed, calculate your start-up costs so you know you have enough funds available.

Think about the expenses you’ll have for launching your business and the likely costs during your first 12 months of trading.

You can then work out how much business you’ll need to generate to ensure you at least break even, or ideally make a profit.

Read our guide for more tips on calculating start-up costs.

In the early stages of self-employment, it's a good idea to keep costs as low as possible.

Ways to do this include:

• working from home
• claiming business expenses
• booking travel in advance to get the best prices
• using video conferencing to reduce travel expenses
• seeking out the best deals for expenses such as broadband, phones, and insurance.

Budgeting for irregular income

Freelancers and the self-employed often have fluctuating incomes, so budgeting is vital.

Work out your minimum income you’ll require to cover all your expenses as you start your self-employment journey.

This includes fixed costs like rent, mortgage payments, utility bills, and variable costs such as entertainment, travel, and clothing.

As your business develops and you have been trading for several months, you will be able to work out your average income, which you can use to refine your budget.

As you don’t pay taxes monthly when you’re self-employed, it’s vital that you budget for these payments so you can settle your tax bill when required.

Once you are paid to do some work, calculate how much tax is due and put it aside.

As a sole trader, you can use your personal bank account for your business finances, but this approach can make life harder in the long run.

Using a separate bank account for your self-employment income helps to stay on top of cash flow and makes budgeting easier.

It is advisable to have an emergency fund for unexpected expenses or a future financial crisis.

Use savings or allocate some of your monthly income to this fund.

Finding and securing funding

You may need external finance to manage your cash flow or fund growth.

To be approved for funding, you typically need to provide a business plan with cash flow and revenue forecasts.

For some types of finance, you need a good credit history.

Grants

A grant is an amount of money for a specific business purpose that you don’t have to pay back.

Public sector organisations often provide grants, although private businesses offer them too.

You’ll receive the full amount for some grants, but others are match-funded, which means you’ll need to provide a proportion of the funding yourself.

Grants are listed on the gov.uk website, with country-specific databases on government sites for Wales, Scotland, and Northern Ireland.

Business loans

Loans are money you pay back with interest over an agreed period.

Loans can be:

• secured – where you use an asset from your balance sheet as security, such as equipment or property
• unsecured – no business assets are required as security.

Sole traders may find accessing bank loans more challenging than limited companies because lenders may perceive them as riskier.

Sole traders may find it easier to get a personal loan.

An example is a Start Up Loan, which is government-backed funding between £500 and £25,000 with a fixed annual interest rate of 6%.

Credit cards

A credit card provides credit you must repay once you’ve used it.

Although some credit card companies offer interest-free periods, you must typically pay interest on balances you do not clear each month.

Useful resources

Here are some helpful tools and resources for financial planning and budgeting:

• Download a cash flow forecast template
• A guide to business forecasting
• Download a personal survival budget template
• How to set realistic expectations as a start-up
• Profit and loss account explained
• 10 ways to strengthen your cash flow.

Becoming self-employed is exciting and provides a significant opportunity to control your destiny, enjoy financial rewards, and achieve personal growth.

But when you work for yourself, it’s essential to plan and keep an eye on your finances to have sufficient money to enjoy the experience.

Have a continuous learning attitude and seek professional advice when needed to adapt your financial strategy.