The pain. The horror. Making a budget for an irregular income just can’t be done!!!
I hear this stuff all the time. There are a million excuses for not starting a budget… but that’s just what they are – excuses. Budgeting for inconsistent income is no different.
Sure, it’s easier to create a budget when your paycheck doesn’t change from month to month. But that doesn’t mean you should just give up and shoot from the hip. Heck no!
When you make an inconsistent income, budgeting is more important than ever. During the good times, you need to plan carefully. That way, your bank accounts don’t run dry during the slow months.
You can do this. It might seem like a tall order, but creating a budget for an irregular income is actually pretty easy once you learn how. I’ll give you the secret sauce in a minute, but let’s get started by reviewing a few budgeting basics.
Creating a Baseline Budget
We’re huge fans of keeping a monthly budget. Budgets help you seize control of your financial situation by planning for your income and your spending every month. In fact, getting on a budget is a key part to getting ahead with your money.
Our favorite type of budget, a zero-sum budget, helps you harness the power of your paycheck to make the most of the money you already earn. With this method, you create a plan for every dollar you take home. This helps you stop wasting money and start discovering funds you never even knew you had.
To budget for an irregular income, start in the same place.
The goal of a zero-sum budget is to “spend” every dollar you make into different categories. That way, each dollar has a clear and specific purpose. You’ll know where all of your money is going so you don’t end up wasting it throughout the month.
Here’s the formula to make it work:
Income – Expenses – Savings = Zero
When everything balances to zero, you are in total control of your money. Set up a zero-sum budget quickly like this:
- Determine your income.– Grab a sheet of paper, and create a category at the top labeled income. Now, determine your income for the month. Jot it down. Because your income fluctuates, we’ll base your initial budget on the least amount of money you’ll make during a single month throughout the year.
- Determine your expenses.– Now, grab all of your monthly bills and separate them by category. Add up each category, and jot down the total.
- Determine your savings.– Subtract your expenses from your income. Whatever you have left over is the amount you can safely save. Since your income fluctuates, you may not have anything to save yet. You may even be short. That’s OK. We’re going to show you how to even out your income in a minute.
- Prioritize your expenses.– If you don’t have anything left, you need to prioritize your expenses. Start by ensuring you have enough to cover your food, shelter, utilities, and transportation (in that order). After those expenses are accounted for, you can start allocating funds for your discretionary expenses (stuff like cell phones, cable TV, restaurants, entertainment, etc.).
- Calculate what you need.– When you run out of funds, stop. This is your baseline budget. It’s what your budget will look like at its tightest. At a minimum, you always need at least enough money to cover the four essentials each month.
Alright, let’s move on to the real reason you’re here: Evening out your income.
Dealing with Income Swings
So, your income goes up and down. Some months you’re swimming in cash; other months, you’re scraping by on your baseline “bare bones” budget. Wouldn’t it be nice if there was a way to smooth out those wild income swings.
There is. I call it a “Boom and Bust Account.”
Creating a “Boom and Bust” Account
This little trick might just change your life. Seriously.
When trying to budget for an irregular income, creating a Boom and Bust Account is the biggest key to success! This gem helps you save money during the good times while supplementing your budget during the bad. It spreads your available income evenly throughout the year, making it easier to plan your budget from month to month.
In my experience, a Boom and Bust Account is easiest to understand by looking at some examples.
Let’s assume you work a seasonal job where the majority of your income is earned during the summer months. Last year, you made a total of $50,000 in take home pay – an average of $4,166 a month. Of course, that money doesn’t come in evenly.
From April to October, you brought home a total of $40,000. For those 7 months, you averaged $5,714 in take home pay. But, you only took in a total of $10,000 over the other 5 months – an average of just $2,000 per month.
It’s super tough to budget if you don’t have some way to even this out. But, with a Boom and Bust Account, you can.
Because your short for a period of five months every year, you need to save for that shortfall when business is booming. But how much do you need to save?
First, calculate your average monthly shortfall during your bust period. In this case, your average monthly income is $4,166 but you only make $2,000 on average during your bust period. Thus your average shortfall is $2,166 a month. ($4,166-2,000=$2,166)
Now, multiply your average shortfall by the longest period of time you fall short – in this case 5 months. So, in our example, a fully stocked Boom and Bust Account would have $10,830 in it. ($2,166 x 5 months)
So, how do you save that money? Easy. Do it during the boom time.
Every month you make more than your average monthly income, save the overage in your Boom and Bust account until it is full. Using our example, let’s say you make $5,500 in August. Keep your average monthly take home pay to handle your current expenses ($4,166) and save the rest in your Boom and Bust Account ($1,334). Do this every month until you have a fully stocked account.
Clear as mud? Let’s try another example.
Let’s say you make a nice living as a commission-based salesman, taking home $80,000 a year. Last year, you experienced a drought where you didn’t get paid a dime for 3 months. Here’s how to handle it.
- Estimate your total annual take-home pay:$80,000
- Calculate your average monthly take-home pay:$6,667
- Determine your longest shortfall period:3 months
- Determine your average take-home pay during the shortfall:$0 / 3 months = $0
- Calculate your average shortfall during the bust period:$6,667 (total average) – $0 (shortfall average) = $6,667 average shortfall
- Calculate your fully stocked B&B Account:$6,667 (avg. shortfall) x 3 months = $20,001 needed
So, to smooth out the bumps during the year, you need to save $20,001 during the boom periods. Seem like a lot? You can do it!
Remember, any earnings over your average should be saved during your boom periods. If you take home $12,000 one month, sock away $5,333 ($12,000-$6,667 = $5,333). When you make just $5,000 next month, dip into the fund to cover the $1,667 shortfall. That might seem like a huge amount, but you’ll thank me when you go through a dry spell.
Quick Tips to Budget for an Irregular Income
Now that you know how to create your own Boom and Bust Account, here are a couple of quick tips to help you stay on track.
- Keep your B&B Account separate. – Be sure to keep your Boom and Bust Account separate from your other funds. Don’t mix it with your emergency fund. Don’t mix it with your savings. Keep it in a separate account so you have to make a conscious decision to use it for balancing out your income swings.
- Keep your B&B Account liquid.– Make sure the money in your Boom and Bust Account is easily accessible. You don’t want this money tied down. Also, resist the temptation to stick it in something like a mutual fund. Remember, this account is purely for helping you level the swings of irregular income. It’s not meant to be used as an investment. Instead, work your other savings goals into your monthly budget.
- Underestimate your income.– I find its always best to underestimate your income and overestimate your shortages. That way, in the event your estimates are off, you’ll always have a little bit more than you need. Of course, you don’t want to swing too far in the other direction either. If you’re way too conservative, you’ll create an artificial shortage of cash… and being short on cash is what we are trying to avoid!!!
- Reevaluate your needs.– It’s a good idea to check in with your progress a few times every year. That way, you can see if you are meeting, exceeding, or falling short on your projections. If you’re too high or too low, make adjustments to your Boom and Bust savings as needed. (Again, I like to stay conservative in my estimates. That way, I always have more than I need.)
Creating a budget for an irregular income can seem daunting, but a little planning goes a long way. Save more during the good times so you can relax during the bad.