Calculating Freelancer Income in the UK

Is it better to work at 100% capacity for a low rate or half the time for double the rate? In fact, what does end up in your pocket after all is said and done?

It’s easy to focus on the Gross Revenue when we should look at the Net Profit. You might know the expression “Profit is Sanity, Revenue is Vanity” — let’s do the numbers to back this up.

In this article, we will look at how much you take home at the end of the day and how best to structure your rates and time.

We’ll look at whether you should focus on large but irregular work, or whether to have lower cost but consistent work. We’ll also look at how best to slice up your earnings.

Your money earned as a freelancer then has to be sieved through various tax instruments before you get it.

We’ll look at how you can arrange your freelancer revenue to be tax efficient. We’ll look at some of the rules for UK companies and how you can use our spreadsheet to get a clear understanding of what goes where.

We’ll show our workings so you can understand where your money goes. As with most money-related matters, a professional accountant is an invaluable resource – so use and check this with them.

The aim is to help you put aside the right amount of money so you don’t get hit with unexpected tax. From there, you can set targets and work less for more.

Let’s convert your daily rate into an annual net income.

 

Want to jump ahead? Click here to view the Google Spreadsheet.

Your monthly capacity

What are we working with? There are 260 weekdays in a year. In England, there are 8 Bank Holidays which are included in your 28 days minimum holiday. In total that leaves us with an annual work capacity of 232 working days which equates to 19.3 billable days per month.

Depending on your business, you will likely require a few days per month for general housekeeping. It is unlikely that you will need to hit full capacity of 19.3 days. In fact, you may be freelancing precisely because you don’t want to work every possible day of the month.

Let’s take a generous example of working at 75% capacity. This would result in you having 174 working days per year or 14.5 billable days per month. That will be our target for the days you get paid per month in this example.

N.B: This allows you to take just under 4 weeks of holiday a year, which is nice.

Working out your Day Rate

What you charge per day depends on what the market will pay for your services and how much you need to make. Let’s use the 14 days per month as a basis for how many days we need to work. From this, we can plot how different rates bring home different annual salaries.

Once this is done we need to understand how your revenue is whittled down by your outgoings to become your net income.

First, let’s clarify some of the language used so we are on the same page.

Gross: The figure before outgoings such as tax

Net: The final figure after all outgoings

You have a Revenue then a Profit and then finally an Income. We will run through the process from Revenue to Net Income. Net income is the final amount you take home.

When we have this calculation we can make a more informed decision on your day rate. The aim is to choose a day rate that works for the market and for you.

At this point, you are welcome to load up the spreadsheet and view the different Gross Day Rates and Net Day Rates. Below is a summary of how they compare.

It’s clear there is a fair difference. We will examine how your Gross Revenue converts to Net Income, but first a quick word about your outgoings…

Outgoings

You have to spend money to make money as any hustler in a Hollywood screenplay will spout. As with everything financial, the more you can quantify and categorise, the better insight you will have. Make a note of what you are spending and where. If you use an accountancy tool like FreeAgent or Xero, then you are in luck as they do a lot of the heavy lifting for you with an itemised breakdown of outgoing/month.

Certain outgoings are tax-deductible and others are not. You’ll need to investigate that yourself, depending on your specific outgoings.

I will give a very simplistic (and totally unrealistic) example to demonstrate how a tax deductible expense works.

Example: If I have a Net Income of £500 and £100 of tax-deductible expenses, then I only have to pay tax on £400.

N.B: I have included an example table in the spreadsheet where tax-deductible outgoings can be added.

What’s getting taxed?

There are a few taxes to consider:

  • Income Tax (personal tax to be paid via self-assessment)
  • Corporation Tax (tax to be paid as a limited company)
  • National Insurance Contributions (personal tax to be paid via self-assessment but dependent on salary you recieve via the company)

If you have a limited company, as a director, your income includes both your salary and dividends.

There is a tax rate for your salary and a tax rate for your dividends. The total of your income (salary + dividends) determines the tax band you belong to.

Income Tax Band Taxable income Tax rate Dividend Rates
Personal Allowance Up to £11,500 0%
Basic rate £11,501 to £45,000 20% 7.50%
Higher rate £45,001 to £150,000 40% 32.50%
Additional rate over £150,000 45% 38.10%

 

The important thing to remember with the bands is that you are only taxed on the amount going over the threshold. So if you have a total income of £46,000 which is £1000 into the higher rate band then you only pay the 40% rate on that £1000 over and not on the entire amount.

  • No income tax (remember that’s sum of your salary and dividends combined) on the first £11,500
  • You’re taxed 20% over an income of £11,500 and up to an income of £45,000
  • You are taxed 40% on any income over £45,000

But it is not that simple. We need to factor in our dividend allowance and our national insurance contributions. With this in mind we can structure how much we take as salary and how much as dividends.

Dividend Allowance

You don’t pay tax on the first £5,000 of dividends in the tax year (from 6 April to 5 April the following year.)

National Insurance Contributions and Salary

You will need 35 years of contributions to get the full amount of your state pension, so this is worth paying and we’ll include this in our calculations.

To qualify you need to have a salary above the lower earnings limit (LEL) which is currently £490/mth or £5,880/year. As long as you are above that, you get full credit no matter how much more you pay.

National insurance is a tax of 12% and kicks in at the primary threshold which is £680/month or £8,160/year. Therefore this is the typical salary recommended by most accountants for owners of companies. At this salary, you will pay no national insurance contributions but be eligible for the state pension (after 35 years).

This is why we have set the salary per person at £8,160 in the spreadsheet.

Hat Tip to Brighton based accountant Simon Peters for clarifying this and a link to a bit more on the subject:

Optimal Director’s salary for 17/18

Summary so far

Let’s just reaffirm a few things at this point…

Dividends are taken from the Net Profit of the business and not the Gross Profit.

Gross profit = revenue – outgoings 

Revenue: We’re looking at a range of day rates multiplied by the number of days per month. For instance 14 days at £300 = £4200 per month revenue

Outgoings: Includes salary and overheads. We’ve set our salary (with consideration to our NIC quota) and we’ve also listed our overheads (expenses). From this, we can then determine our Net Profit.

Net profit = Gross profit – corporation tax

Next, we need to consider corporation tax before we can start taking dividends.

 

Corporation Tax for Limited Companies

If you are operating as a limited company, you need to consider corporation tax. If you are a sole-trader your personal assessment determines your tax contributions and you are not required to pay corporation tax. For 2017-2018 Corporation Tax is set at 19%.

Corporation tax is applied on your gross profit. To determine Gross profit work out your outgoings (outgoings = salary + overheads/expenses) and then minus that from your revenue (revenue = total sales before tax.)

 

Taking Dividends

When we have our net profit we can then draw the dividends from this. You don’t pay tax on the first £5000 of dividends, but after that, the basic rate is 7.5% up to £43,000 of income.

The tax band for income tax is higher than dividend tax, so this is more efficient way to structure your payments. That’s the reason why we have kept the salary at £8,160. That’s enough to qualify for NIC without taxing that income. We are then taking dividends which are taxed at this lower rate of 7.5%.

Have a look on the spreadsheet near the bottom of the Advanced sheet where there is a tax breakdown of this information.

Multiple Shareholders and Dividends

Many freelancers work in partnership with someone else. Often this is their partner. A usual setup is to have a Ltd. company with two directors as shareholders.

If you are working with another director then you will need to adjust the days accordingly. You will also need to bear this in mind in your calculations of salary and dividends.

We’ve included a field in the spreadsheet. Change this field to 2 or 1 depending on how many directors there are.

The spreadsheet does assume the shares of the two directors are equally split. Dividends are split according to share amount, and you will need to take this into consideration.

Using a spreadsheet to calculate your net income

So far we have looked at:

  1. The days we can bill for
  2. How that totals to our Gross Income
  3. The ways to structure your outgoings, salary and dividends so that you are fulfilling national insurance contributions and reducing your tax bill.

All the above information has been compiled into a Google Spreadsheet that you can use as a template.

Use the following data fields to check how much you take home:

  • Day Rate
  • Days per month worked
  • Number of Shareholders

If you look at the Advanced table it shows everything. The summary table just shows main fields from Advanced.

 

In summary

  • IF you worked 14 days at £400 per day
  • THEN your Gross Revenue is £67,000 per year
  • AND your Net Income is £48,206 per year to be shared among the shareholders.

 

Take a look at the raw numbers in the Spreadsheet by clicking here

 

Working fewer days with a higher rate

It’s interesting to compare working fewer days per month at a higher rate. At the start of the example I proposed the question:

“Is it better to work at 100% capacity for a low rate or half the time for double the rate?”

First a word about fixed overheads. In the digital world, which is where I reside, overheads are relatively fixed. For digital freelancers, it makes little impact on their overheads whether they charge £300 or £1000 a day. This is an assumption I have included in the spreadsheet. This may not be true for everyone. You are welcome to dig deeper and copy the spreadsheet so it better reflects your own figures.

This may not be true for everyone. You are welcome to dig deeper and copy the spreadsheet so it better reflects your own figures.

It does, however, show us that there are greater margins on all revenue above this baseline.

If you work 9 days a month (48% capacity) at £300 a day you earn £17,586 income per year.

You might think that if you work twice at much, if you work 18 days a month for the same day rate, then your income is just doubled.

You might think the income should be £35,172 (£17,586 * 2) but actually, it is £41,862. This is because of the greater margins above the baseline of your outgoings. There is a multiplier effect on all work over this baseline.

Put simply, you are getting much more in income the more you work over your baseline.

 

There is, however, no financial difference in pay between working 9 days at £600 per day or 18 days at £300 a day. The graph above shows this.

There are many secondary benefits of a higher day rate. The most important being that you can reach a steady level of income and know that some months you will have an opportunity to increase your capacity and take advantage of the multiplier effect and increase your net profit for that month.

Having more time not working for clients also means you can spend more time marketing and work on your business. The kind of work you need to do to attract higher paying clients.

Ultimately, it is somewhat academic to propose that you are going to double your rates to £600 if there is not a market to sell your services at that price. Use these kinds of spreadsheets as a guide. Use it to set a target for the number of days you need to work.

I’d love to hear your side on this. How do you determine your day rate? Do you have targets? Do you prefer consistent lower paid work or irregular high paid work? What are the other considerations to bear in mind? Higher paid work can involve more risk, it can require more stress.

However, in some instances, it can be counter-intuitive. The lower paid work can be harder because your services can be valued less. These kinds of considerations are very client specific.

It would be great to hear from a variety of different disciplines about their experiences. If you have a moment, scroll down to the comments and leave us a note.

 

 

Extra Note: Consider tax as a monthly outgoing

This is included in the spreadsheet and I recommend considering this. You don’t have to pay tax every month, but it is smart to put aside cash every month so that when the tax bill arrives you can pay it off. It’s common for businesses to put off saving for their tax bill and then they get stung.

It’s easy to avoid this by calculating your tax and then putting the correct amount aside every month.

Extra Note: VAT Registration

The VAT threshold is based on revenues over £85,000

Once over this threshold, you are required to charge 20% VAT tax. This is tax deductible.

Leave a Reply

Your email address will not be published. Required fields are marked *

Name *