There are lots of things for creatives to think about beyond having good ideas. We’re here to help, with our advice series Stuff They Don’t Tell You. James Cartwright takes you through the dull, but vital world of tax and finance for freelance work.
Illustrations by Cate Andrews.
If I were to tell you the following article contains the terms revenues, expenses, assets, public liability, and professional indemnity, there’s a good chance you’d shut this piece down and never return. But hold your horses.
Seriously, just hang on a minute, because this accountancy stuff is complicated and ungainly, but once you’ve mastered it as a freelancer, your one-person business will be forever safe from the tax man. They say that if you teach a person to fish they will feed themselves for a day, but teach them the basics of freelance accounting and they’ll be able to feed themselves for a whole lifetime.
For most people, going freelance will be the first time they’ve had to manage money outside of their personal finances. As an employee you show up, work your hours, then go home, and that sweet lump sum arrives each month like clockwork. But did you ever stop to wonder about the work involved in making sure that it did?
“The understanding of business that most people have before they go freelance is of being an employee,” says Brighton-based accountant Matt Virgo (my accountant, as it happens). “They’re not business people – they do a job and they get paid for the hours they work. But what they need to understand is that they’re no longer selling their time.
“They’re not sitting in a cubicle from 9am to 6pm and getting paid for it. They’re getting paid for delivering a service, and that’s very different.”
As an employee, your mistakes are the responsibility of your employer. When you’re delivering a service, you alone are responsible for the quality of that service. If you screw up, legally the weight of that failure is on you, and your clients have a right to recourse (i.e. money) if you deliver anything that breaks the terms of your contract, or they decide isn’t up to scratch.
Which has what to do with accounting exactly? Well, the first part of self-employed accounting is working out what you should charge for your time. As we’ve already seen, it’s not just the hours you need to consider.
“If you’re freelancing, you take on all the responsibilities of an employer,” Matt says. “You’re taking on responsibility for being unpaid if you’re sick or if you want to take holiday. You need to account for a pension and factor in everything that you’re sacrificing by not having a good employment contract.” Considering all of these factors will help to determine your fees.
It’s also important to consider the additional value you provide to a client above and beyond your core services. Hiring a freelancer comes with plenty of advantages, not to mention a load of bureaucratic processes that can be skipped. Every time a client chooses you over an employee, they’re saving on social security or national insurance and pension contributions, potentially private healthcare and dental cover too.
They don’t pay for your laptop, your desk space, chip in for a monthly office lunch, or shell out for your meal at the Christmas party once a year. All that’s on you.
It’s for exactly that reason that freelance contractors have become so popular in so many industries recently. But there are complicated sets of rules and regulations that restrict the provision of personal services offered to a client, and breaching them could mean having to pay hefty sums in backdated tax. This is not in line with the footloose and fancy-free entrepreneurial spirit in which our gig economy is usually portrayed.
All of which is to say that the first rule of basic freelance accounting is to know your rights and obligations in detail, because without an employer you’re personally, potentially painfully, exposed. There exists a huge number of strange, confusing rules and regulations, and if you don’t understand them it’s easy to come unstuck.
Here’s a few key pointers to getting your freelance finances straight...
Get a dedicated bank account
As far as I’m concerned this is the big one, although in all honesty it’s a rule that I still don’t follow myself. As a result, my business accounts are a constant hassle to wrangle, as expenses go out of three to four different accounts and I sometimes accept payments through Paypal.
When I sit down to work out my revenue and expenses each month I have to itemize everything from five or six different locations. Learn from my mistakes. As soon as you go freelance, set up a dedicated account for all your business finances and attach a credit card to it to take care of those occasional big spends. Then watch as the money enters and exits in glorious orderly fashion. Doesn’t that feel nice?
Another basic rule that I have personally ignored for years; I’ve been uninsured, I’ve been vulnerable and I’m lucky I never got sued. You shouldn’t take on the liability of a contractor without having some kind of insurance to protect you.
There are three types of basic insurance that all freelancers should consider:
Public Liability insurance covers you if someone is injured or their property damaged in the line of work and you or your business is held responsible. That might sound abstract and unnecessary, but given the flexible nature of work, it’s best to be on the safe side.
If you’re an artist and someone is injured while visiting your studio, Public Liability insurance has will keep you secure. If you’re a photographer and a model hurts themselves on your set, Public Liability insurance will take care of that too. Some contracts with clients will specify that you have this cover if you’re working as part of a team of contractors, and if you don’t, you won’t get the gig.
Professional Indemnity insurance is much more specific. You’ll need this if you provide consultancy or advice to your clients. If the advice you provide ever loses them money, they can sue you for your dubious ideas. If they do, you’ll be glad of that Professional Indemnity Cover.
You need Employer’s Liability insurance if you have employees, even just one. It covers you if your employees are injured or get sick through work, and covers compensation to the tune of millions. If you don’t have it, the fines can be business-cripplingly huge.
Start a spreadsheet
I hate them, you hate them, we all hate them, but you need one, so start a spreadsheet! Embrace it, make it your friend, make it work hard for you. Track your revenue, track your expenses, itemize your assets, color-code it in whichever way is most appealing to your eyes. I use this one. It’s ugly. It works. You’re welcome!
Decide on an accounting system
Thankfully there are only two different types of basic accounting: cash basis, and accrual. With accrual accounting, you record your revenue and expenses when you earn or consume, with cash basis you record them when you’re actually paid or make a payment.
Clear? Me neither. An example, if you please. Say you invoice for a project on April 3, but are paid on May 12. Under cash basis accounting you’d record that revenue in May. Under accrual, you’d record the same earnings in April, when you sent the invoice. Under accrual accounting you declare the revenue you’ve invoiced whether your client has paid you or not.
In most cases it’s best to use cash-based accounting as it saves you from paying excess tax on revenue that hasn’t yet been paid.
Keep your receipts
Hang on to every single one of those slippery little chaps. Organize them by date and type to ensure they’re easy to process. If you decide to use accounting software like Quickbooks, you can snap a photo of each one and catalogue it immediately. If you’re a Luddite like me you’ll neatly arrange each one inside a lever arch file and thumb them affectionately at the end of each month.
Set aside your tax every month
Sounds like a no-brainer but it’s painfully easy to get caught out. Keep in mind that the contents of your bank account won’t all be available to spend, and you’ll need to keep a percentage aside to pay your annual tax bill.
With all these things it’s best to set aside more than you think you’ll need. I save 20% of all my earnings even though I have a personal allowance of £11,000. It makes it feel like you’ve received a gift when it finally comes to handing over your tax.
If you’re lucky to make over a certain threshold you’ll have to pay a higher rate of tax on anything additional that you earn. To be honest, if you’re earning enough to pay more than the basic rate you probably don’t need this piece at all.
In some places, you’ll be asked to pay your tax on account, meaning you make biannual or quarterly payments based on estimates of your earnings. This can actually be quite a useful way of ensuring that you save accordingly.
Then set aside a little more
If you’re sick or need to take holiday, this extra little pot of cash is going to make all the difference.
Charging VAT on top of your earnings is a legal requirement if you’re making above a certain amount, but you can also do it voluntarily if your income falls below. Depending on your circumstances this can be a beneficial move as you can claim back the cost of VAT on assets and expenses that are essential to the running of your business, and if all your clients are VAT registered it won’t make a difference to them.
These pointers are just the basics for freelance accounting in general. The intricacies of rules and regulations will vary depending on where you live. It really can’t be stressed enough how important it is to understand this stuff, so take the time to read around the tax and small business specifics that apply to you – for example US, UK, and EU tax vary wildly.
Get you a (wo)man that can do it all
Get an accountant. They’re good people (mine even helped with this article), they save you money and if nothing else they understand this stuff much better than you. They’ll help you navigate the choppy seas of your freelance finances and keep you from going overboard if things get really rough. Good luck!