Financials are an exasperation for anyone in the world, except for maybe accountants, but the troubles of finance can be a little different for contractors. There is more than the usual household bills to be concerned about, but with careful planning and a decent accountant, financing can be a walk in the park.
One of the first things you will need to get to grips with are timesheets and invoices. As a contractor, you will likely be operating on a daily or hourly rate with unfixed hours, and so in order to get paid, must inform your end client as to how much time you have spent on the contract.
If you are working through a recruitment agency, then the agency will likely provide timesheets which both you and your end client will need to sign. It is always a good idea, particularly on an IR35 standpoint, to have your own timesheets as well, and always keep a photocopy of your timesheets in case there are ever any discrepancies in payment.
Alongside the timesheet, you should always prepare an invoice. This should include your company information, an invoice number and date, details of the payment including how many hours, rate and total, when the payment is due by, applicable VAT and terms of payment. It is also useful to include bank details or cheque instructions. The more information you put on your invoice, the more chance you have of getting paid correctly and on time.
Remember to make copies and keep them in your records file.
Whereas a permanent employee has their taxes done for them and expenses are usually paid for by their employer in the first place, contractors must understand and calculate their income tax, employers’ national insurance contributions, employees national insurance contributions, VAT and corporation tax, as well as ensure all tax returns are submitted timely and correctly. A good accountant is key for when it comes to sorting through the minefield of tax, but if going it alone, organisation will be your new best friend. Having a calendar prepared with deadlines and information on how to complete the returns and where to pay them is useful but don’t forget to add alarms at least a month prior with regular intervals leading up to the deadline to ensure completion is made on time.
With contracting, there are a greater number of expenses that their employee counterparts never have to deal with as part of their work, such as insurances, accountancy fees, phone bills, equipment, training, marketing investment and travel expenses. Once again, careful planning and organisation are key. It is important to list all expenses as annual, monthly and one-off with approximate costs and budget accordingly. Your accountant will be able to assist you with which are claimable and which are not.
Going on holiday, falling sick and gaps between contracts are all common causes of taking time off work and this is probably one of the bigger worries for contractors when it comes to their finances. A permanent employee gets paid for their holidays and when they fall sick, as well having a steady, secure income with no gaps to worry about. Contractors, on the other hand, must look after themselves out when it comes to taking time off. The good thing is that contractors also have a much greater flexibility in managing their time off work and when they take income from the business. This means, once again, good planning will be your saviour.
Having at least 6 months’ worth of cash set aside in the event that something puts you out of work, such as not being able to find a new contract or the strike of an illness can be the difference between pulling through, and bankruptcy. As well as having a rainy day fund, insurances such as medical insurance are also a consideration for unforeseen circumstances. Policies vary greatly so make sure you do your homework before parting with your cash.
High street mortgage lenders are notoriously difficult for contractors to get anything out of, as contractors do not have a full time permanent position and may not have the required three years of accounts, or the rates eventually offered are sky high.
There are now a few providers who specialise in contractor mortgages, allowing contractors to get better rates than they might find on the high street and not be met with instant rejection but an understanding of the flexible workforce. As with most things, shop around and read the terms and conditions thoroughly before settling: most contractor specialists will charge a percentage fee.
Although most of us put aside retirement planning for ‘future us’ to deal with, without the benefits of permanent employment which usually include company pension schemes, contractors must think a little bit further ahead if they wish to have a comfortable retirement.
Putting money into a pension fund will not only help you greatly in later life but will also save you tax now. Pensions come with a tax incentive to encourage people to save and thus put less pressure on government funds, so you can channel money to a pension fund instead of to the tax man and reap the benefits later. By investing from your limited company on your behalf, you will also make savings on corporation tax. Putting company earnings into your pension fund will also help reduce the headache of IR35: if you were caught by the legislation then all of your income for the period in question would be subject to income tax and national insurance contributions, but the money which went into your pension fund is essentially exempt. Therefore, the more earnings you put into your pension, the less will be at risk to backdated liabilities, interest and penalties from an IR35 investigation.
Remember that you cannot touch a pension fund at all until you are 55 when you can draw 25% as a lump sum. With the rest, you can either draw out on an annual basis but limits apply, buy an annuity (a plan with a pension provider) which will give you a regular income until the inevitable or leave it as inheritance.
Finances are the backbone to a company; they are vital but they often cause us grief. It is important to attack finance with a head-on approach with efficient and careful planning and quite a bit of effort. You should start by sitting down and taking the time to address all of the points above and then discussing it through with your accountant who should be well versed in contractor problems and be able to advise you. You are, however, ultimately responsible for yourself and your company, and therefore will need to do your homework and make your own decisions on what you need and what is best for you.