January is great and August is terrible, or maybe every month is different and completely unpredictable. If you’re an economic independent (self-employed, sole practitioner, founder of a start-up, consultant or small business owner), you probably have experienced an uneven income. When you’re starting out, it’s particularly difficult, especially if you’re the only person making money in your household.
You need a “slow month” fund and here are the 3 steps you can do to smooth your uneven income by creating a slow month fund:
1. Know how much you need to run your business and take out of it to run your household each month. You should have a cash flow of your business and your household.
If it takes $3,000/month to run your business and $6,000/month to keep your household running, you need your business to generate $9,000/month.
2. Know your business. Know the good months and the slow ones. Watch your billing cycles, take a look at your last year on quickbooks, look at your appointment book or take a look at your pipeline of projects.
Figure out how short you will be on each of your slow months. Maybe you know that summers are slow and you generally make just over half of what you make the rest of the year. That’s June, July and August and you make (e.g. profit after expenses and tax) $6,000 instead of $10,000 from your business. Three months of being short $4,000 means you need a slow month fund of $12,000 ($4,000 * 3 months).
3. Fill your slow month bucket. Using our example, we need $9,000/month for our business and household. Every month that you make more than $9,000, take every dollar over $9,000 (yes, EVERY dollar) and put it in your slow month account until you have at least $12,000 in your slow month fund based on the example given here.
When your slow month fund is low because you’ve used it to supplement when income is low, go back to step 3 and repeat.
The key is that you know your business well enough to know when there are down months and great months. It’s also critical to be disciplined enough to save for slow months instead of taking more money out of your business for your personal use. It’s tempting to do so, but then when the slow months come along, you will find yourself having to charge items you normally pay right away in order to get through the month, which is a very slippery slope.