Five finance mistakes I see from freelancers

I’ve spent my entire career so far working closely with freelancers - starting out as an expenses assistant at a contractor and freelancer umbrella company, and most recently within my own accounting practice dedicated to freelancers and contractors. In these years, I’ve come up against a few recurring challenges when it comes to designers and developers keeping a check on their finances.

Not keeping on top of bookkeeping records

The biggest problem that I see is that freelancers often don’t keep good quality and accurate financial records. I think it’s because many freelancers think that record-keeping is only important for tax purposes or to keep HMRC happy, and they don’t really see the benefit of doing it for themselves. To me, it’s the single most important thing that you can do for your business - with accurate records in place, you are in a much better position to catch any potential cash flow problems, to plan your tax bill, and generally to make good business decisions.

I’ve found that many freelancers don’t know where to start when it comes to keeping business records, or even what “good” records look like. A good accountant can help you here, but here are some of the basics that you should make sure you’re doing:

  • Make sure you’re recording invoices and that each one has a unique, sequential invoice number
  • Regularly check that the balance in your accounts match the balance in your business bank account - any small problems can cause a lot of hassle later on
  • Ensure that you record all out of pocket expenses you have incurred on behalf of the business so you can be reimbursed in full for these
  • Keep track of supplier bills so you can pay these on time and keep in your suppliers’ good books
  • Maintain copies of all receipts and bills for your record
  • Make sure you are keeping an eye on the business’s bank balance so you have enough cash available to cover the upcoming payments

It is easy to leave bookkeeping at the bottom of your to-do list when you are busy, and I’ll be the first to admit even as an accountant that is not the most exciting of tasks. However, not keeping on top of your financial position, particularly when managing your cash flow, can be a make or break situation.

Not having a personal tax plan in place

Another common problem I’ve seen when working with freelancers is that many start spending money that they earn without a firm tax plan in place. I’ve seen many cases of freelancers who have misjudged their tax bill, then ended up with an unexpected personal tax bill come January - not great timing just after all the Christmas and New Year celebrations!

Ideally, you should sit down with an accountant or tax advisor before the end of each tax year to look at your expected income for the next year, then you can forecast your tax bill based on this.

During the year, if your keep your records up-to-date, you can use your current balance sheet to see the amount of cash the business needs right now to cover its upcoming tax bills.

Not making the distinction between your personal account and business account

As a freelancer, it’s sometimes hard to get your head around whether you and your business are the same legal entity:

If you’re trading as a sole trader, you and your business are considered the same legal entity by HMRC.

If you’re the director of a limited company, you and your business are considered separate legal entities.

There are a lot of real-world repercussions of this distinction between legal entities. For example, because limited companies and their directors both have their own distinct assets and liabilities, the director’s assets are legally protected in a way that a sole trader’s is not.

For directors of limited companies, this also means that the cash in your company’s bank account isn’t technically yours - it belongs to the company itself. To get cash out, the company would either need to pay you a salary, or pay you dividends (more on these later).

If you’re a sole trader, technically you could operate your business out of your personal bank account, but it’s not a very good idea because it makes it harder to keep costs and income separate. It’s much easier to keep your accounts up-to-date and understandable if you use a separate business bank account.

Mixing up out-of-pocket expenses and costs

Along the same lines, I also often see freelancers incorrectly recording personal out-of-pocket expenses and direct costs from their business bank account. Here’s the difference between the two:

An out-of-pocket expense is something that you paid for from your personal bank account, and need to be reimbursed for by your business (from the business account).

A direct cost is something that you or the company paid for from the business bank account, and no reimbursement is required.

For example, many freelancers accidentally record an out-of-pocket expense as a direct cost, then when they reimburse the amount back to their personal account, their accounts go out of balance. This can build up to cause a lot of duplicate entries and discrepancies within your bookkeeping records, and can cause a lot of confusion when you’re trying to get a clear view of how much money you have available.

Not keeping a check on dividend withdrawals

As I explained earlier, directors of limited companies may have the company pay them directly from the profits the business makes, otherwise known as a dividend payment. This is a popular way for freelancers to pay themselves, as it involves less tax. Here’s the difference between a dividend payment and a salary:

The company could pay you a salary as an employee of the company, whether or not it has made a profit.

The company can pay a portion of profits out to shareholders of the company, but only if it has made enough profit.

So to be able to pay a dividend, the company must firstly have made enough profit to cover the amount of the dividend payment. I’ve often seen freelancers mistakenly thinking that the company had enough profits for a dividend and withdrawing money in error, normally because they didn’t have an up-to-date view of their finances. Drawing a dividend without there being available profits to cover this could result in your having to pay funds back into the business.

My top tip for freelancers

If I had to give one piece of advice to anyone working as a freelancer, it would be that bookkeeping records aren’t just a paper trail for HMRC or even your accountant - they’re an integral part of running your business and planning for the future. All of the issues that I outlined above could either be completely solved or caught much earlier by keeping up-to-date books.

I appreciate that freelancers already have to wear a lot of hats - developer, designer, marketer, salesperson - and that bookkeeping often comes to the bottom of the pile. I’d recommend trying to manage your books in small, regular chunks to make it more manageable, rather than saving it up. The time you invest will not only save you a lot of hassle (or unexpected tax bills) in the future, but it will pay you rewards in terms of insight about how your business is doing.

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