My name is Mark Goodfield and I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is about income tax, business, the psychology of money and investing topics and is meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations. I also blog about whatever else crosses my mind; I have to entertain myself. This is my personal blog and the views and opinions expressed in this blog do not reflect the position of Cunningham LLP. I am blunt and opinionated (at least for a Chartered Professional Accountant). You've been warned.

The blogs posted on The Blunt Bean Counter provide information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Wednesday, December 14, 2011

Tracking expenses made easy

I have written about the importance of budgeting a couple times. The first time in my blog Where Did My Money Go, I suggested using software to track your monthly expenses.

In another blog on budgeting Budgets and underestimated household expenses, I relented on the detailed tracking and suggested you only keep detailed records for one month supplemented by the tracking of other exceptionally large expenses.

In my final discussion about budgeting, I relent on even the one month detailed tracking and suggest an alternative solution provided by Robert Chown, a financial advisor at one of Canada’s largest investment firms. Robert, author of You Can’t Eat Your Furniture, offers a simplified solution to detailed budgeting.

In chapter two of his book “Cash Flow Is Everything,” Robert suggests that you spend your money on only four things: (1) taxes & deductions (2) debt payments (3) savings & (4) living expenses.

Under Robert's simplified Household Cash Flow Statement the problematic issue of tracking living expenses is not necessary, as it falls out into a sort of "remainder" category. Here's what Robert suggests:

1. Take the total of you and your spouse’s yearly employment salaries, and add any known investment income to get your sources of cash.

2. Total all the taxes you pay on your employment income (just use the tax paid on your pay stub and multiply by the number of pay cheques you have each year).

3. Total all your debt payments for your mortgage, car payments, student loans, etc. most of which are known at least a year in advance.

4. Summarize your savings. This will include all the money you set aside to contribute to your RRSP, RESP, TFSA, the purchase of a new car, etc.

5. Subtract from your sources of cash the totals of the taxes, debt and savings and you then have your living expenses.

Once you have undertaken this exercise, you will know how much you can spend a month on living expenses without a detailed tracking analysis or looking back on December 31st, know how much you spent in the prior year. Here is an example from the book:


Household Cash Flow
Description
Monthly Payment
Betty
Bob
Total
Pre-Tax Income

35,000
80,000
115,000
#1 – Taxes and Deductions

(8,000)
(24,000)
(32,000)
After Tax Income

27,000
56,000
83,000





Debt Payments




    mortgage monthly
    line of credit
    car lease
1,525
300
250
-
-
-
-
-
-
18,300
3,600
3,000
#2 – Total Debt Payments



24,900





Savings




    RRSP
    RESP

-
-
6,000
2,000
6,000
2,000
#3 – Total Savings



8,000





#4 – Living Expenses



50,100



This shows that Betty and Bob will be able to spend roughly $50,100 after tax on living expenses or if done as a year-end review, that they spent $50,100 in the prior year. Robert thinks this technique is more accurate than detailed tracking of expenses because people often miss expenditures that can add up to big money. This can lead them to significantly underestimate their living expenses and overstate their surplus cash flow. Just because someone didn’t record an expense doesn’t mean that it didn’t happen. That’s not a problem with this system because any dollar earned but not directed to the first three categories ends up in the fourth. It has nowhere else to go.

The Household Cash Flow works well for people with no debt or those who are paying off their debts in an orderly fashion. If you are digging yourself a hole due to overspending on “living expenses,” then you probably need to address your spending in more detail.

The Household Cash Flow Statement also provides some potential retirement income data. If you assume you will be debt free by retirement and no longer have a requirement to save for retirement, you can eliminate two of the four items you spend your money on (Debt payments and Savings). The only two things left are Taxes and Living Expenses. Your current living expenses are a starting point for the expenses (in today’s dollars) you will need to cover in retirement, plus or minus adjustments for any expenses that will appear or disappear in retirement.

If you are not the type of person to track expenses, this is an alternative method to provide yourself with some spending details and a simplified base for retirement planning.