Out of the rat race and flat on your face

Last week's disruption in London, when IRA bomb threats brought the capital's transport system to its knees, might prompt even the most loyal company executive to think about leaving the rat race to the rats.

Many other people, of course, become self-employed out of necessity, having been made redundant. One way or another, half-a-million newcomers try self-employment each year, says the Federation of Small Businesses, and that number is likely to increase. Unfortunately, many of these new businesses fail and a substantial proportion of the failures are professional people, who chance their redundancy or retirement package on their venture. Even businesses that continue to trade may struggle for several years, with the once-optimistic entrepreneurs finding themselves less well off than they were when working for someone else.

It is not just the failure of big earnings to materialise quickly, or even the loss of the benefits of being an employee that makes the difference to how well-off you feel. Running a business of any size costs money, and people who go it alone are shocked by how much it costs to replace the facilities employees take for granted. How many people in an office know how much it costs to photocopy a memo, or to buy a pack of Post-it Notes? When it is your business, you need to know, as it is your money.

Predicting costs is an inexact science but as a guide many self-employed people estimate that overheads could account for half their previous salaries. This could even be at the lower end of the spectrum. Management firms, for example, charge a daily consultancy fee which is three times the salary of the adviser. This reflects the true running costs of the business and, of course, profits. For the self-employed, profits have to come before "salaries". You meet business overheads and any money that is over, the trading profit, is yours to spend.

This is one of the hardest concepts to adapt to, according to experts who advise people starting self-employment. Employed people have a salary that is fixed in advance, then arrange their spending within that budget, including any loans they take out. This is not the case for the self-employed. Businesses have fixed costs, such as renting premises, or buying a computer, that have to be met before they can trade. According to Phil Dowell, lecturer in entrepreneurial management at City University Business School, you have to invest to earn. Successful self-employed people have to create the right environment to work in. This comes before any fee-earning work, but Mr Dowell advises businesses not to skimp, even in the early stages.

Unfortunately many vital goods and services cost small businesses far more than they would larger firms. Large companies negotiate discounts on anything from an airfare to a phone call, from a health policy to car insurance. As Mary Reilly, a partner at Arthur Andersen, the accountants, explains: "Companies might provide permanent health insurance or Bupa cover, which they get at a special rate because they buy in bulk. If you go out to buy that yourself, it is a lot more expensive than a group scheme."

The cost of a daytime business phone call is another example of how larger businesses gain better rates. BT offers big discounts - 31 per cent off standard rates - for firms spending pounds 25,000 or more a quarter.

Furthermore, in many cases the financial services industry offers the self-employed a worse deal than the employed. Most importantly it can be difficult to get a mortgage and you may be charged more, while it may be harder to get sickness and other insurance policies to pay out if you are self-employed.

The other, hidden cost is in marketing and running the business. In spare moments at work it is easy to jot down a potential daily fee, multiply it by the number of days in the week, and come up with a turnover that is far more attractive than a salary. However, anyone who has started a business will warn that more time than you expect is swallowed up by administration, invoicing and, especially in the early months of self- employment, marketing.

Managing these costs demands a good business plan. The high-street banks and the various enterprise agencies all offer good advice on projecting costs, revenues and marketing a business. Much of this advice is free. If the product is good and the costs are realistic there is every chance of success. But it is also important to remember that self-employment is always a step into the unknown, and an expensive gamble.

Next week: should you set up your own limited company and should you register for VAT?

SOURCES OF ADVICE

The high-street banks all offer free packs for new businesses. They are part of their marketing operations, but contain useful advice none the less.

Business Link is a national, government-backed network of advice centres for new or growing firms. Call 0345 567765.

The Federation of Small Businesses offers an advice pack, "Be Your Own Boss". Call 01253 720911.

Specialist advice for people who plan to work from home, or away from clients, is available from the Home Business Alliance or the Telework, Telecottage and Telecentre Association. Contact HBA on 01354 658850 or TCA on 0800 616008.