#Budgeting, #Household Math - Budgeting - Income

Question

I've done the budget process for expenses. Now what?

Answer

Let's now add income to the budget...

Analysis

It's time to add in the Income numbers into the budget and oddly enough this can be the harder part of the budgeting process.

With expenses, we want to identify all the expenses we incur over the course of a year, then display that on a monthly basis (we've done that part in prior posts). We use the Accrual Method to identify expenses as they are incurred so as to prevent surprises. Surprise expenses are no fun.

With income, we want to identify it as it's received - the Cash Method. One of the tendencies in budgeting is to project a rosy future where the promised raise at work is a sure thing, where that tax refund will be large, where a long lost relative died in the Congo ages ago and selfless lawyers have searched for years to find the heir - and it's you. We don't want to budget that in - if it happens, great and if it's periodic, we can budget it in (if the raise does indeed happen, adjust your budget!). Surprise income is a good thing.

For most people, income starts and ends with a salary. When we budget, we're going to want to budget the "take home pay" - not the gross pay. It's great that you have a job that pays $50,000 per year, but if you only take home $40,000 of that, that's what goes in the budget.

This also goes for people who receive pensions and other sources of periodic payments. Include what you know you are receiving. If and when an announcement comes that it's being changed, adjust your budget accordingly - if it's good news and the pension is going up, adjust the budget when you actually have that first payment in the bank. If it's bad news and it's going down, adjust the budget immediately and see if you'll need to change anything in your lifestyle.

Another common way to "overstate income" is to look to bank interest and other sources of investment income like that. Unless you have your finances set up to be living off of investment income (and we'll talk about that below), don't include it.

Ok - people who live on investment income, people who own a small business, or otherwise whose income varies. It's important to pick an income number that focuses more on the lean months than the rich ones - and it may be the case that budgeting into the expense side of things a "float" that income overages can go into and that reverse during the lean months. Doing something like that will require constant vigilance on that account - it's been set up to be there when income is lower, so you need to make sure it's nice and full when income is plentiful.

I've updated the budget example here:

https://docs.google.com/spreadsheets/d/1kCtMSNnKUXhvJT9yif5wtl5jbEsmyFz9mQ-IV62_U4g/edit?usp=sharing

and you'll note that we have a situation where the income is less than the expenses. We'll talk about that situation in the next post.

This post is part of a series on budgeting - Budgeting 101

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As always, questions and comments are welcome!

#Accounting - Cash accounting vs accrual accounting - what's the difference?

Question

What's the difference between cash accounting and accrual accounting?

Answer

Cash accounting focuses on transactions being recorded as monies are received/paid out. Accrual accounting focuses on transactions being recorded as monies are earned/obliged to be paid out.

Analysis

There is an adage in business that "Cash is King" - it means that no matter what else you have - the number of machines that produce products, the number of buildings, the amount of land, etc - that if you don't have cash, your business is in big trouble.

Because of this, and also because it's by far the simpler method to keep track of a business' books, people will use the Cash Method of Accounting. In essence, you only track transactions that involve cash when you actually receive/pay out that cash.

For instance, if a company sells $100,000,000 worth of product on account, under cash accounting, that sale is only recorded when the cash is received. Before then, for the purposes of bookkeeping, it hasn't happened. On the flip side, if a company borrowed $100,000,000 and the payment is due next week, that payment is recorded until the cash is paid. Even if it's paid late.

As you might suspect, while being by far simpler to use (which is why many small businesses use it), cash accounting can severely distort the apparent financial condition of the company. And so another method arose to help better reflect the actual condition of the business - the Accrual Method of Accounting. Using the accrual method, transactions are recorded when amounts are earned (regardless of actually receiving the cash) or obliged to be paid out (again, regardless of actually paying out the cash).

For instance, if the company makes a large sale, the account Sales is increased (Credited). To reflect the fact that money is now owed to the company, a Receivable is also increased (Debited). On the flip side, as interest on that huge loan builds up, it is recorded as a Payable (Credit) and an Expense (Debited).

When financial statements are prepared, an accountant needs to make sure that all amounts that are accruing (such as that interest expense, or as another example a salary expense for salaries earned by workers but as yet unpaid) is updated as of the date of those financial statements.

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Comments and questions always welcome and appreciated!