My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog do not reflect the position of Cunningham LLP. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

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.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

5 comments:

  1. I like this approach. I used to track every penny years ago, but once my debts were well under control it seemed a bit much. This suits me better. I just did it for 2011 and the "living expenses" answer is pretty close to what would have guessed - within two hundred a month.

    Would you calculate your savings rate based on gross income or net of taxes? In the example, based on "net" its not too bad at almost 10%. But based on gross it seems light.

    Thanks, and keep up the interesting posts

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  2. Hey Bill

    There is no right or wrong answer, but the general consensus is to use your income net of taxes, since that represents your true available cash position.

    There is also no right or wrong savings number, any positive is good these days based on the rate of debt Canadians hold. Although there are many variables, I would suggest 10% of net is not terrible; however, without knowing your income situation, kids at home, one or two income family and actual spending I cannot provide more than that genric answer.

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  3. Thanks! I wasn't looking for anything specific, other than "use net".

    I am a compulsive saver anyways, but I am trying to teach my teenage daughter (who just started her first job, 6 weeks before Christmas) the value in saving, and starting early. It is more uphill than I would have hoped...

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  4. I like this in theory, but it would never work for me, and likely others with more debt than what this budget allows for. I need the relentless penny tracking version - at least for now. Hopefully, if that does what it's supposed to do, I'll be able to transition to this simpler type of household budget.

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  5. Hi Anna, I agree with you 100%, as stated in the blog this "short-cut" does not work if you have significant debt. I have relented on this type approach because I have seen first hand people just are not willing to track spending. If you are/become a relentless penny tracker, you will only be the better debt wise for it, good luck.

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