#Budgeting, #Household Math - Budgeting Basics - Expenses

Question

How do I budget for expenses? 

Answer

This will take a few posts to do, but in this one we simply identify all the possible outlays you experience and put them in a spreadsheet.

Analysis

As we start preparing a budget, it's important to first identify where money goes. Do you pay rent or a mortgage? Pay for a car? Insurance? Gas? Or perhaps transit - maybe a daily fare or a monthly transit pass? Utilities? Cable? Phone (landline and/or mobile)? Food?

Let's first list out those items that you know about into a list (we'll be modifying the list, and so using a program like Excel (PC), Numbers (Mac), or Sheets (Google - it's free and can be used online). Here's a sample:

Mortgage
Condo Fees
Condo Insurance

Water
Electricity
Gas (Note: the heater and stove are natural gas)
Cable

Phone, landline
Phone, mobile

Groceries

Dining out

Auto payment
Auto insurance
Auto fuel
Auto maintenance, repairs


And perhaps you have other expenses that need to be added into this list. If you think of it, write it down!

Once you've done that, take a look at your credit card statement for the past few months. Do you see things there that aren't on the list? Clothing? Add it. Video games? Add it. Go ahead and put in all the categories you think of.

I've built a google spreadsheet to follow along with these posts (it's view only):

https://docs.google.com/spreadsheets/d/1ZxwZz7Nn5ZYVV-x6HgPavTP6wkfIswP8-NTvV9gTTR4/edit?usp=sharing

In our next step, we'll add numbers.

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

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As always, questions and comments welcome!

#Budgeting, #Household Math - Budgeting... What's it good for?

Question

It's great that I read everywhere about the need for a budget, but what is it?

Answer

A budget is a tool that people use to figure out their financial health.

Analysis

I like this definition enough that I'll repeat it:

A budget is a tool that people use to figure out their financial health.

The most basic question that can be answered is "Am I living within my means?". More complicated questions can also be answered, such as "Can I afford that expensive thing?". Questions involving more involved financial questions, such as "At what age can I retire?", will probably require a Personal Wealth Plan of some sort - simply analyzing monthly spending probably will be insufficient to answer that kind of question.

The main idea behind the budget is to see where your financial strengths and weaknesses are. Where there are financial weaknesses, you can then develop strategies to deal with them. For instance, if it turns out expenses are higher than income, the budget can identify that that is the case and then steps can be taken to address it.

To budget, we look at the two sides of financial life - Money coming In and Money going Out. In future posts, I'll reference topics in the post about the Statement of Cash Flows for a business because there will be some overlap in concepts.

The first place to start is to think about your expenses and how often they occur. For most people, the big expenses occur once per month (rent/mortgage payment usually being the biggest of them all). And so, in general, it's best to work with a budget that looks at a monthly timeframe (we'll deal with non-monthly expenses and incomes in their respective sections).

I think the last thing to say about what a budget is is that it's something that can be quite individualized. Depending on how exacting you'd like to be can greatly affect the budget. What are the items you want to track? What are the items you don't want to track? Generally if there is a lot of guilt and shame involved, like perhaps the "amount of money spent at coffee shops" or "the amount of money spent online shopping", those are items that need the most attention!

In future posts, we'll talk about the How of budgeting...

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

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As always, comments and questions are welcome!

#Accounting, #Household Math - Moving the accounting into the home...

Question

Do accounting principals apply to my personal financial life?

Answer

Absolutely! See below for a few ideas...

Analysis

Bookkeeping and accounting really only refer to the tracking of financially-related transactions over the course of the life of a financial entity. That entity can be a company, a government, or a person/family - to anything that conducts any sort of business, accounting applies. Of course, as the complexity of the entity increases, so do the challenges of recording those transactions and making sense of the resulting information.

One of the ways we see how this applies is in the preparation of tax forms. When filling them out, you are essentially asked to account for income that's been made (from various sources and it matters where money comes from because the tax treatment can change based on the source). Alongside that, you are also asked to account for specific types of expenses - say for instance mortgage interest - because those monies spent are treated as deductions (and again, the reasons for those payments will determine how the tax calculations are done). For most people, taxes are a nightmare requiring frequent sleepless nights, gathering information. However, if an accounting system is implemented and used throughout the year, the burden (physically and mentally) of filling out the forms would be greatly decreased.

Another place accounting shows up in a household is through budgeting (company's call it financial forecasting or some such other term). What is anticipated that will be made in income? What is anticipated that will be spent? Is the income number bigger than the expenses number???

And one more place I'll mention is in the area of Needs vs Wants - or the making of financial decisions. For instance, while there is a need for a car, does that mean you need the newest Mercedes? On the other hand, is it financially better to buy an old clunker, given that it'll need more repairs and work?

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Comments and questions always 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!

#Accounting - What's a Balance Sheet? What's an Income Statement?

Question

What's a Balance Sheet? What's an Income Statement?

Answer

They are the two most basic accounting statements/reports. The Balance Sheet answers "Where are we right now?" and the Income Statement answers "How much did we earn over a given period of time?"

Analysis

 I've talked about T accounts and Debits and Credits in prior posts. The Balance Sheet and Income Statement arise directly from the activity recorded in the T accounts.

When preparing an Income Statement, we look at a period of time. For instance, a statement that is being done to show the activity for the year ending December 31, 2018 will be titled "Income Statement for the year, ending December 31, 2018). The report itself lists Sales and other Income related to the ordinary course of business (natural Credits) and subtracts from that Expenses and other costs related to the earning of that income (natural Debits).

When preparing a Balance Sheet, we pick a date that the statement will be of. For instance, a statement that is being done as of December 31, 2018 is titled "Balance Sheet as of December 31, 2018" (exciting stuff, right?). The report itself lists Assets on one side (the natural Debits) and the Liabilities and Equity on the other side (the natural Credits). The activity from the Income Statement is listed as a change in Equity.

Together, the two reports show a company's activity from ordinary activity and can be of tremendous help in guiding management and other decision makers on the health and activity of the business.

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Feel free to ask a question!

#Accounting - What are Assets? Liabilities? Equity? Income? Expenses?

Question

In accounting, what are Assets? Liabilities? Equity? Income? Expenses?

Answer

• The simple way to think of Assets is to think of them as things the company owns. If the company owns equipment, furniture, the building it's in, it's cash - these are all assets. Sometimes things that are assets are not held by the company - money owed it by customers is an asset (called a Receivable) - the company may not have the money in-house but the fact that it is owed money means that it owns the right to that money. Assets tend to be natural Debit accounts.

• Again, working within simple explanations, Liabilities are those things that the company owes. When the company buys things on credit or takes out a loan, these are amounts that are owed by the company to other entities. Liabilities tend to be natural Credit accounts.

• The difference between what the company owns and what it owes is what the company is worth. This is its Equity (oftentimes called Net Equity, Net Worth, Owner's Equity, and other similar names). When a company is incorporated, the shares of the company are part of the equity (there will be some mention as to the equity per share or a way given to calculate it). Equity tends to be natural Credit accounts. 

• The way a company brings in money or other assets through the ordinary course of affairs is called Income (note that this is different than when a company does things such as selling an investment or raises money by obtaining a loan. These activities, while it will bring in money, is classified under Investing and Financing activities). Sales tend to be natural Credit accounts.

• In like manner, when money or other assets are expended through the ordinary course of affairs, these are called Expenses. Expenses tend to be natural Debit accounts.

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Feel free to ask a question!

#Accounting - What's a Debit? What's a Credit?

Question

What's a Debit? What's a Credit?

Answer

 Debit is the Left Side of a T account. Credit is the Right Side.

Analysis

Remember the post about T accounts? Debits refer to the numbers on the left hand side of the vertical bar of the T and Credits refer to the numbers on the right hand side. It's as simple as that - different names for Left and Right.

When I was first learning the concept, at every opportunity I could find, I'd refer to things on my Debit side and on my Credit side. I'd turn Debit and Credit in a car. It was the only way to get the concept firmly planted in my head.

Accounts will hold what is sometimes termed "natural" balances. Assets and Income are typically natural debit balances (that is, to increase the account, we debit it) and Liabilities, Equity, and Expense accounts are typically natural credit balances (that is, to increase the account, we credit it).

At this point, you might be wondering why it is that when you are getting money back from a vendor (say like from the phone company), they say they're going to "credit your account". Or even when you deposit money into your bank account, it's called "crediting your account". Why is that?

The answer is that the customer service people are working from the viewpoint of the company. When they are giving you money, they are decreasing the company's money, or in other words, they are decreasing the company's assets, and that is a credit.

For a bank, it's a bit different. When someone makes a deposit into a bank, we are increasing the bank's assets, which is a debit. But what the bank is really interested in is the fact that they now owe you, the depositor, that same amount of money you just deposited in. In fact, when you, the depositor, get your bank statement saying that you have $1,000 in the bank, the bank has a liability for that amount (we'll talk more about liabilities in a future post) - they owe you that money at a time of your choosing. And so the teller, in working with your assets, is in actuality working with the bank's liabilities. When you had the teller money, you are increasing the bank's liabilities, which is a credit.

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As always, please feel free to ask a question!

#Accounting - What's a T account? Why use them?

Question

What's a T account? And why use them?

Answer

A T account is a simple but effective way to organize the activity in any given account.

Analysis

Let's first talk about accounts. An account is a way to gather similar activity in one place. For instance, over the course of a year, let's have Sample Co. have a number of sales throughout the year. We can sum up those sales to see the sales activity for the year. For an example, let's have Sample Co have sales of $100,000 for the year.

This $100,000 sales figure is made up of smaller sales throughout the year. We list them individually as they happen. A part of that list might look like this:

$500
$1000
$250
$300

and so on.

Some transactions will increase the balance of the account and some will decrease that balance. Take the account Cash for instance - as sales are made, cash comes into the company. As inventory is purchased, salaries are paid, and other outflows are accounted for, the balance of the account decreases.

One way to show this would be to list out all the transactions in a single list:

 $1,000
-$350
-$15
-$25
$300

and so on. Which can get messy.

Another way to look at the accounts is to put all the amounts that increase the account in one list and all the amounts that decrease the account in another list. To save space and to keep things organized, we can draw a T, put the account name above the crossbar of the T, and have amounts on one side of the T's vertical line increase the account and on the other side put those amounts that decrease it. It'll look something like this:


        Cash
------------------
$1000 |
           | $350
           | $15
           | $25
$300   |

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As always, if you have a question, please ask!

#Household math - Which is the better way to pay for an online school when dealing with referral credits?

Question

I'm looking at joining an online school website that has over 22,000 courses in all sorts of different topics (I'm interested in some portion of them that relate directly to my interests). The cost for joining this website is $15/month but if I join for a year, I pay $99. To make things more complicated, I have 2 coupons for 1 month off each (one is the usual offer from the website and the other is as a referral coupon - I got one and the person who referred me also got one). What's the best way to join the website?

Answer

It's best to subscribe for a year, unless you are going to receive 2 or more referrals every month. 

Analysis

This is an interesting question because of the twists and turns in what's available in terms of options. The key is going to be to put everything on equal terms so that we're comparing "apples to apples".

Let's look first at what happens if we look at the options without regard to the coupons. We're comparing the regular monthly cost of $15 vs the monthly cost of $99 over 12 months, which is $8.25 per month. Clearly it's better to pay less per month! But... what if you don't use the site for all 12 months? What's the number of months that'd you have to use the site on the yearly plan to have it cheaper than paying $15/month?

We can find that by dividing the yearly cost of $99 by the monthly cost of $15. This gives 6.6, or in other words, it's better to pay by the month if you'll use the site for 6 or less months. For 7 or more months, it's better to pay the yearly amount.

Now let's look at the coupons. When paying by month, the coupons give 2 free months (and so for the cost of 1 month for $15, you get 3 months). When paying by year, you get 14 months for the cost of 12. What that works out to be is, when paying monthly, $15 for 3 months is $5 per month. When paying yearly, $99 for 14 months, that's $7.07 per month. And so there appears to be a better financial result to pay for 1 month and pay $15, use the site for 3 months, then change over to a yearly plan. However, that ignores a couple of factors, and so the best way to calculate this is to calculate the monthly cost over the course of the annual plan, then look at the associated monthly cost.

Using the yearly plan, you get 14 months for $99. Using the monthly plan first and then paying for the year, you get 15 months for $15 + $99 = $114. To compare the two, we divide the $114 by 15 (to get the per month rate), then multiply by 14 to get to the same number of months under the yearly plan:

And so it's best to pay for the year and get the 2 free months added on.

The one exception to this would be if there is an expectation of receiving 2 or more referral codes per month. If that's the case, it'd be better to stay with the monthly plan until the likelihood falls off of getting those referral codes. At 1 referral code or less per month, it's better to pay yearly.

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As always, feel free to ask a question!

#Accounting - Accounting requires organization, not advanced math...

Question

I want to study accounting but I'm afraid to do it because I'm not good at math. What are your thoughts?

Answer

The good news is that accountancy rarely goes beyond basic arithmetic (adding, subtracting, multiplying, dividing). In fact, accountancy is far more about organizing and classifying information rather than manipulating it. 

Analysis

As a for instance, let's take a sample transaction and look at how an accountant would treat it.

Stan's Superheroes (a store specializing in superhero collectables) sold a Baitman figurine (it's a knockoff of Batman - this one is of a cowled fisherman who fights crime on the docks) for $10. The customer paid cash. Stan originally bought the figurine for $3. How do we book this transaction?

And now let's watch how an accountant works through this question.

• Cash has increased by $10, so the account Cash is increased (Debit)
• Sales have also increased by the same amount, and so the account Sales is also increased (Credit)
• The inventory has decreased by the amount originally paid for the figurine, and so it decreases by $3 (Credit).
• The last account, which is the Cost of Goods Sold, increases by $3 (Debit).

Accountancy also gets into reasonableness. For instance, would it be reasonable to conclude that Stan's Superheroes makes $1,000,000 per year from sales of Baitman? Probably not - and it's the role of the Auditor (a type of accountant) to examine those types of situations.

Bottom line, most accounting does not involve anything more than basic math. If however you are interested in stretching your math muscles within the accounting world, Cost Accounting might be for you (it's a type of managerial accounting that does it's best to examine a business from top to bottom, in all its processes, and put them into financial terms so that the management of a company can make better business decisions).

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Questions and comments welcome!