I've been a freelance developer for around 2 years now, and in that time I've developed a system to manage my finances when it comes to freelancing, although I initially built up the foundation to the system back in 2018 and 2019. This was when I developed my own personal conscious spending plan. A plan to allow me to live how I liked, spending on whatever I wanted, while also starting to save, invest and making sure I was living within my means.
Quick side note before we get started: some of my recommendations in this post are universal, whereas others are specific to Germany, since financial laws and regulations tend to be country-specific. This does not constitute legal or financial advice, please refer to a licenced professional.
Managing your finances is tricky but it becomes easier by building a system to remove the guesswork. Getting to grips with the additional work like filing tax returns and dealing with health insurance on your own, as well as accurately calculating net income and creating a regimented conscious spending plan will mean you can focus on doing your best work and bringing value to your clients without having to worry about the admin. Here's how to get started.
Straight away, the first recommendation that I will give you if you want to build a strong financial future: Ramit Sethi's bestseller, I Will Teach You To Be Rich. There are certainly parts of this book you can skip, especially if outside the USA as I am, but there are some amazing fundamentals that I took away from this book.
The first being his mantra about living a rich life - "Spend lavishly on the things you love, cut ruthlessly on the things you don't."
In short, find whatever it is that brings you the most joy and happiness in your life, and concentrate your spending on those things.
For example, if you love travel, go ahead and spend your money on trips to exotic places. This is fine as long as you cut your expenses on e.g. your house, your car (by not having one!), your clothes and food. If you're not in a position to spend money on anything, that's a problem, and you should look at building a secondary source of income, getting a promotion in your job or switching to another company or industry that pays better.
The second is the Conscious Spending Plan. It starts off an as expense-auditing exercise. Looking through the last 1 to 3 months, highlight the areas where you spend money. Break it down into 4 categories - Fixed expenses (rent, food, clothes, bills, things you absolutely need), guilt-free (luxuries like fancy coffees, expensive meals, going out, etc), savings (setting money aside) and investing (in the stock market or other asset classes). After that, aim to modify your spending to be sustainable month-to-month. There is a little flexibility but it should look something like this:
|% of monthly income
|50 - 60%
|20 - 35%
|5 - 10%
Play around with those percentages until you can make it add to exactly 100% (duh) and then stick with that plan. Every month, as you spend money, keep track of the expenses you're incurring and allocate them to the correct category.
I like to use GoodBudget, it has a great free plan and the perfect set of features for this use case. I'm sure there are plenty of others out there.
I admit, this part takes effort. It's far from automated and it's easy to forget to log expenses. It gets easier as time goes on, and I believe it's worth it in the long run. Keeping a solid budget is an essential part of efficiently managing your freelancer finances.
As I was in the process of getting my first freelance gig at Deliveroo, I had a lot of doubts about the legal and financial complications of it all. I had a couple of consultations with qualified tax advisors in Germany (Steuerberater, which are the equivalent of accountants in the UK), mercifully they spoke good English, which helped a lot.
The setup required to freelance was simpler than I thought. Here are the basic steps
- freelance ID
- business bank account
- tax returns
- VAT registration and VAT returns (not always applicable)
I had to register with the financial authority (Finanzamt) as a freelancer, something I'd alredy done in 2019 as I had planned to start freelancing on the side back then. I also needed a business bank account. I applied for one with Revolut, since I already had an account there, but they turned me down for reasons unknown. Instead I went with Kontist as they offered a reasonably priced account (just under €11 per month, which I still pay now) and is quite easy to use. They sent me a card, and my account was open, it wasn't any more difficult than that.
The major stepping stone was figuring out how to submit my taxes. An annual tax return (Steuererklärung) costs between €500 and €600 (last time I checked) when filed by a tax advisor, but I didn't like the sound of that. Instead, I chose to use an online tool to simplify it all and make it cheaper. I went with Sorted, which is a very nice tool indeed. It has an expenses section where you can upload all your expenses, including reading your PDFs and printed receipts to gather basic information like total price and data; an invoice generation tool for creating invoices to send to my clients; and crucially a tax form submission function, which can deal with every type of form submission that a freelancer is obligated to do in Germany, including personal tax returns, profit and loss statements and VAT returns. This sets me back €20 per month, but at €240 per year is much cheaper than hiring a tax advisor and also handles for me a lot of the manual tasks that working with a tax advisor would entail.
My client was a UK company, so no VAT rules applied, therefore I didn't have to register to pay VAT. To cut a long story short, if you work with clients outside the EU, you aren't obligated to charge VAT and you don't have to register. Once you have clients in Germany, you need to register to pay VAT, but don't need a VAT number yourself. As soon as you work with clients in EU countries outside of Germany, you need to both register to pay and charge VAT and also apply for a VAT number (so that your clients can claim back any VAT they pay you).
I later registered to pay VAT in May/June 2022 to work with Holoride starting in July 2022. I still don't need a VAT number myself because none of my clients are in non-EU countries.
All in all, the setup was quite smooth and I felt annoyed at myself that I had built it up in my head to be this huge obstacle. It wasn't. Paying a couple of hundred euros to tax advisors helped me learn that (and that's tax deductible anyway!)
Alright, so you've set up your conscious spending plan (which is just a fancy term for budget), are tracking your expenses month to month and you're all set up as a freelancer to take on the hundreds of clients I'm sure are knocking down your door to work with you, now what? Well, it's easy when you're working full-time as a permanent employee. You earn the same every month regardless of the holidays you take, or sick leave, or whatever else. The challenge comes when you apply this to a freelance situation.
I was fortunate in my first 18 months of freelancing to actually be a contractor. The distinction is quite large. As a contractor, you work for a single client, pulling 40-hour weeks and in many ways you're treated as an employee. You're not privy to certain meetings, you might be excluded from channels in the company's Slack and you have to explicitly request permission to view or use basically any of the company's documents or tools. But there's a certain level of consistency.
As a regular freelancer, however, you might not have a steady stream of work. Some months might be very busy, earning a lot of money and not having any holidays because you can't find the time. Other months might be more sparse, with little incoming work bringing in lower earnings and a lot of free time where you can be easily tempted to spend more money. What a nightmare!
As a contractor, you don't worry about where your next gig is coming from, and you certainly don't think about the end of the project or anything. During my 12-month contract with Deliveroo from July 2021 to June 2022, I thought very little about finding clients. In fact, in April 2022, almost 3 months before my Deliveroo contract was finishing, I already had a follow-up contract with Holoride, so I never worried about client at all until 2023 came around.
Why is this relevant? The bonus of contracting is that you know quite accurately how much money you will make in a given month. Sure, you might get sick, but you'll know if you have any holidays and you know how many workdays are in the month, so it's quite easily predictable. As a freelancer working with individual clients, this can vary quite greatly and can sometimes be at short notice.
Another great benefit of contracting is that your income jumps. My budget rose about 50% as soon as I started contracting, just because of the extra income that I was earning.
A massive big BUT at this point is to not raise the budget up to the maximum or even the average of what you can expect to earn in one month. It might seem obvious, but months will still be variable.
Now, you need to calculate carefully with the time you plan to go on holiday. As an employee, this didn't matter, as long as you kept within your holiday allowance. As a contractor, there are no allowances, only the time you can afford to not be working. Holidays cost you double. The price you pay for the travel and other expenses, but now also the cost of not earning any income during the time you're away.
When modifying my budget to be a contractor, I settled on a figure that was about €1500-€2000 less than I could expect in a normal month. After a few months, I even adjusted my conscious spending plan percentages to this:
|% of monthly income
I wasn't trying to be stingy with my guilt-free expenses. I still enjoyed spending frivolously on unnecessary items, but the increase in budget meant that the guilt-free category hardly decreased at all and I continued spending similar amounts than before. I was focussed on pumping money into savings, which was money I used for holidays, and also investing, thinking long-term for the future. The earlier I invested, I thought, the better I would take advantage of compound interest.
At this point, I had my new budget in hand, and with a healthy surplus. I didn't have plans for the surplus, I just knew I wanted it around, so it sat in my bank account, accumululating month after month.
One final thing that I wanted to take care of was contributing to an Emergency Fund. This is just an instant-access savings account where I save money that I might need in case of a rainy day. If I lose my contracting client or if a big, unexpected expense turns up out of nowhere, I don't want it to break my financial plans and cause me to dip into savings that are earmarked for other things, or worse, to sell my investments earlier than I wanted to. I had already started contributing to an Emergency Fund in September 2019 with just €50 per month. When I began contracting, I raised that to €150 per month.
To jump ahead briefly, this emergency fund actually came in really handy this year, when I found myself without a steady client in April. I dipped into my emergency fund and I realised at that point that I had probably been underfunding it up to that point. €150 was a lot to take from my Fixed Expenses category in the conscious spending plan every month, but I should probably have used the surplus income more actively and built up a greater safety net while my income was more stable and predictable.
Alright, conscious spending plan sorted, variable income factored in and everything, let's move onto one of the 2 inevitable things in life: TAXES!
I imagine a lot of freelancers struggle with the idea of calculating and paying taxes. As a full-time employee, you get taxes deducted before you ever see the money. It's an efficient system and the benefit is that you don't ever have money that doesn't truly belong to you.
As a freelancer, on the other hand, you invoice your clients the full amount for your services, they pay you that amount (hopefully, as long you have good clients), and then you need to save a certain percentage to pay tax in the following year. You also need to think about paying for health insurance and a pension scheme. Health insurance is capped above a certain income, so at least there's some predicitability in that, and you can choose how much to contribute to a state or private pension. But income tax depends on your actual income level. I trawled through the German government website to find an actual 100% accurate calculation on how it works because most websites gave an approximate answer only and I wanted to know exactly how much income tax I would. In Germany, there is actually income tax (Einkommensteuer) and a solidarity surcharge (Solidaritätszuschlag), but since the latter depends on the former, I'm referring to them both together as "income tax" to make it simpler.
I also figured that I needed to have a ballpark figure on how much I would earn in an entire year to know how much income tax I would end up paying overall. I calculated that it would be approximately 36%, but I rounded up to 37% to make sure I didn't underestimate my tax and be hit with a bigger-than-expected tax bill when I filed my return.
The crucial aspect in all of this was a Google Sheet that I built to take in how much my income was, how much my health insurance was (this is tax deductible), how much my pension contribution was (this is tax deductible, but only 88% of it, from what I found) and how many other expenses I had in any given month. The €20 for Sorted and €10 for Kontist, that's all deductible, meaning you pay for it with pre-tax euros, not post-tax. Add to that any other business expenses I incurred, things like stationery and software I needed for my work. My sheet takes in all these values and spits out an amount I need to transfer from my business account to my personal account. It also told me exactly how much of that money was mine to keep and spend, which was ultimately what I wanted to make sure I knew how it fit with my budget.
It's not a simple calculation, but it's not rocket science either. If you want to hear more about it, feel free to get in touch and I can tell you all about it. It's boring to most people, though, so let's move on.
As mentioned at the start, I wanted to work out a way that I could ensure I would always have enough money to make my budget each month, without worrying about months when I was on holiday, or potentially when I wasn't working or couldn't work due to illness.
At the end of each month, I pay myself my monthly salary. If it's higher than the budgeted amount, then I'm in the black, I'm happy, and I store that extra money in a savings account that I have on Check24. If I'm in the red, I need to withdraw some of my buffer from the savings account. This didn't happen much while I was still working with Deliveroo, and also in my second contract with Holoride. However, as we entered 2023 and the tech market began to dry up, I realised this might be the year I would need to rely on the buffer as well as the emergency fund.
To cut a long story short, all the years that I'd been contributing a little sum to the emergency fund only covered expenses for about 2 months when I first dipped into it. I didn't need to use it all, so I still have about a month's worth of expenses left, but I now know that I need to start putting more in there when I have the ability to.
My current plan for long-term financial stability and success looks like this:
- focus on earning at least the budgeted amount per month after expenses, taxes and insurance contributions (net income)
- build up an emergency fund to have a least 3 months worth of expenses covered
- store any excess income in a buffer and put it in a savings account
- work on building up secondary income streams and passive income in spare time
- identify parts of the conscious spending plan that can be relaxed in low-income months, lowering the overall budget and making it more sustainable
It's a long journey to get to financial stability as a freelancer. The increased income of contracting is not all it initially seems, given the extra overhead of handling expenses, tax declarations, pension and health insurance contributions, and generally being a self-employed person.
I have invested time, effort and some money into tools that help me along the way, without which I wouldn't be able to easily manage my financial situation, particularly when my income becomes unstable and I need to account for greatly changeable earnings. Here are the commercial tools that I use on a regular basis:
- Kontist (paid) - business bank account
- Sorted (paid, free tier available) - tax and reporting software
- Check24 (free) - savings and investment accounts
- GoodBudget (free, paid tier available) - budgeting application
Alongside those, I built a tool to calculate my billing, taxes and income in Google Sheets. If you'd like to learn more about this, please get in touch with me.