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Bills, bills, bills—we all have them. Many of us have more than we can handle. Most of us would like to get rid of them. The funny thing about bills—we create them with joy and jubilation. We’re excited about the items we purchase, the opportunity to go to college, our new car, and our new home. We’re excited about the opportunity to have platinum status on credit card with high credit limits. We’re excited to be independent and on our own. But when the bills start rolling in, we begin to look at the various bills we’ve accumulated as obstacles. They hinder our ability to save, invest, and pursue various goals, and have fun.
In order to have a financially stable life, income and expenses need to be consistently measured, tracked, and controlled. In order to get ahead financially, it’s imperative that you have wiggle room between your outgo (debt and expense) and your income. The larger the margin between your income and your outgo, the easier it will be for you to pay your bills, save, have a life and achieve your financial goals.
Sounds simple? If you have a full-time job or fixed income with a consistent pay cycle where you’re paid weekly, biweekly, or monthly—you know how much to expect from one paycheck to the next. Knowing how much money you can expect coming in gives you a base to determine how much you can afford to spend each month.
What if you don’t know how much you’ll receive from one paycheck to the next? What if you don’t know when you’ll receive your next paycheck? Individuals who are self-employed, independent contractors, or fully commissioned cannot predict with certainty when they will receive a paycheck or the amount of their next paycheck. Yet the bills keep coming. A common problem amongst people with sophisticated income sources is that many of them develop a lifestyle based on their most productive months. They take on expenses assuming that they have broken the unpredictable income barrier. Armed with newfound confidence, zeal, and a decent size unpredictable paycheck, they go out and purchase extravagant stuff with long term repayment schedules. An unfortunate reality sets in when subsequent months produce mediocre paychecks. How does one balance predictable expenses with unpredictable?
When it comes to investment and compensation—the riskier the endeavor, the greater the potential reward. People who are self-employed, independent contractors or receive a large portion of their income from commission take own a lot of risk. As a result, they have the potential to earn more money than people with full time jobs. There is no ceiling on how much money people with unpredictable income can make. Their income is directly related to their individual performance and/or their ability to generate sales. When you have a job when your income is unpredictable, it’s imperative that you develop a system to measure, track and estimate how much income you can expect to make on a month-to-month bases. The only thing you can predict about unpredictable income is that your income will fluctuate from week to week, month to month, and year-to-year—yet your bills will remain a constant. Below are tips on managing predictable expenses when you have unpredictable income:
First Rule: Identify your average income over a full year. Reviewing your income for a full calendar year and dividing that number by 12-months will give you a monthly average. For example, if you earned $45,000 from January 2011-December 2011, your average monthly income is $3,750.00.
Second Rule: After you have calculated your average monthly income, you have a more realistic view of how much you can afford on a month-to-month bases. You should form a budget based on your monthly average. Ensure that all of your expenses are within your monthly average. Using the example above ($3,750 or below per month).
Third Rule: As you begin to experience increases in the amount you’re earning on a month to month bases, use the money to pay down and/or payoff outstanding debt or use the money to build a cash reserve. Too often people with unpredictable income sources notice an increase in income and begin to immediately take on additional expenses. Before you take on additional responsibility you have to ensure that your extra income isn’t temporary. You prove this by reviewing your annual gross income the next calendar year. If it proves that you have indeed earned a raise only then should you consider taking on new responsibilities. For example, your annual gross income from January 2012-December 2012 is $50,000. Considering your income in 2011 was $45,000, you have increased your income. Your budget will now be based on you earning $50,000 per year or $4,166.67 per month.
A more conservative approach would be to average your income over a two-year period. For example, $45,000 (2011) + $50,000 (2012) = $95,000. Your average income over a two-year period is $47,500. Using the more conservative approach, you would base your budget earning $47,500 annually or $3,958.33 per month.
(Damon is owner of ACE Financial. He can be reached at 412-856-1183 or visit his website at www.allcreditexperts.com.)