Wednesday, August 17, 2016

Personal Economy - Running Your Household Money in Profit

I am a seasoned home economist. Some years ago I put a really accurate P & L spreadsheet together, in fact it was 1999, and this has basically been my tool for managing personal and home finances ever since. I say managing, it is really about analysing and the shocks you get are what creates management! Some years later I also developed a cash-flow spreadsheet, down to two week cycles to try and understand why I was out of pocket some months and empty for ready cash until the next e-pay-cheque.

Two Key Concepts to Watch

Before I go further I would say there are two main findings I have to share with you dear reader.  FIRSTLY that it is the seemingly small things which eat your budget down to the bone. Secondly, cash flow is really vital to understand and get on top of. These are in fact not unrelated topics. Life's little extras, luxuries, indulgencies and in particular monthly subscriptions and memberships lead often to negative cash flow and the need for credit to pay for even shopping, but especially things like holidays and car repairs.

Use a Spreadsheet or if Hipster,  Old Fashioned Balance Ledger Book

You will only really effectively manage your monthly budgets by having a spreadsheet - more on that later, but look at any Profit and Loss or product management spreadsheet. In effect your monthly outgoings and income are a balance sheet of your operating profit or financial health if you like. A terminally sick patient goes progressively into operating debt, exposes themselves there in by too much risk. We exclude here any capital gains or losses which are generally covered for in the mortgage for your house. Another capital loss is though cars and they depreciate faster than shit stinks, but that is another topic in itself. We take here that you manage your car loan and resale value, your mortgage and your boat, pension, college fund etce by simple monthly payments included in your operational spreadsheet and turn over.

I would preach as I practice that we include food on our 'cost of goods' because it averages out over time in the actual costs we see in our bank statements, and we set a budget for it, Food is of course a necessity, and it is difficult to sort out drinkies if they are shopped at the same time.  . Here food and drink accounts for 30-35% of our net income because it is so expensive. I recommend using your old bank statements or cut and pasting pdfs or online bank balance sheets onto excel as an "actual" dipstick each month, and over time you will get used to both knowing your "run rate" costs of living and budgeting for them so for example, food does not get extravagant.

Cash Flow is King, Well Almost King

Cash flow is both simple and complex to understand and get a handle on when you look at your finances. Money comes in, but if more goes out before you have it in again you go empty and need to use your overdraught or credit card to span the gap. It is like a wave out in the ocean, with peaks where you have seemingly a lot of ready cash, and troughs where the cash is near empty, or you actually creep into debt. Low troughs of negative cash of course, then spread over to the next peak, sucking your next crest of income. You are bankrupt when all you have is trough despite your income, the bottom is too low to cover by the next income. However as with many, many businesses you need not be profitable in the long run, but still survive on a cash flow which is positive. This is not a very balanced approach, but many business use their suppliers to fund their business simply by getting customers to pay earlier than they pay suppliers by several weeks. Usually they like to syncronise maximum income from customers to CASH in bank with maximum outgoings like monthly pay, and then have cash left over a few weeks before they eventually pay suppliers. Very often they can enjoy free credit from suppliers who are a bit lax on penalty or interest cost, or negotiate long payment terms like running month 60, which means they get upto 90 days circa credit if they buy at the first day of a new month.

Breath out!  You and I use credit cards or the hateful payday loans if we experience that we need to pay for things just before we get paid ourselves. We more often have a negative cash flow from unforseen costs arising at the "wrong time" or we have been spend thrift and used too much money in the cycle. We can be locked in this for years, all the time because of a simple shift of a week or two which imbalances our cash flow. What we need is a higher wave at some point so we can roll over the deeper troughs. We need some 'working capital' or extra liquidable cash on hand, and we need to get our cost payments the right side of the peak - in the time ahead of it, not just before. Credit cards can help with this, but only if we know that in fact, we are making a profit in the mid to long term (6 months to 2 years say) ie our net income will exceed ALL our costs over that time by at least 5%- a semi healthy state of affairs for a corporate.

We can get credit cards which offer running month plus 14 days, ie they consolidate the calendar month's useage and bill you right at the start of the new month, allowing 14 days to pay, usually without interest if you settle 100%. However there is the risk that you are doing this on the 'never never' as the old Scots' saying goes, it is just covering up for you having too many outgoings relative to your income. Credit costs and with emergencies like car repairs or dental treatment, suddenly you can find yourself with a minimum payment, mostly composed of interest, of say €100 euros or dollars.

Home Grown Gross Margin

Now we come to part two of the important stuff - nibblers and gross margin. A profit and loss balance sheet for operational management accounting or product management, places income (sales) at the top, followed by cost of sales, cost of production and so on, what they choose to allocate to deduct from this top line operationally, (depending on nation, state, size and type of company). Most often though, there is a simple calculation of health half way down the sheet, and this is sales income minus cost of goods (to make) and this is known as gross margin. If the company did nothing else but sell things they made straight from the end of the production line, no marketing or distribution costs, then this would in a hypothetical world be their profit. They have this left over to invest, pay tax avoidance accountants, have a party at christmas for the staff.

For you Cost of Goods in the cost of living - all your essential costs. For you and I these often seem fixed costs, mortgage, car loan and so on, but also variable costs like food and electricity ( gas , wood etc) A warm house, well fed, roof firmly over your head. Your family income per month must cover these, otherwise you will drown in debt or get repossessed. Also back to cash-flow, ideally you want to build a wave of cash or ready release savings which is two to three times the size of these costs, such that you can weather a large drop in income.

We have a degree of seasonality in terms of essentials- winter costs more for some in fuel for example, or we get most utility bills in January-February.

We also of course have other costs, often many small, some "essential" like say commuting costs, and after we take these away from our Gross Margin, by calender month  - include then christmas or festive spends and so on - We get a handle then that we are either in profit, covering all our forseen (from our history and planning ahead well) costs, or not breaking even. We see what the bottom line is, and for us it is most important month to month, but with forsight so we can put money into that cash flow wave before the costs crash it down to a trough.

The Fulcrum Effect

Small drops in income have a large effect on the bottom line because the additional costs companies have in covering a manufacturing, sales and distribution network are fixed, and take time to reduce in line with sudden reduction in turn over, or the price they can demand in the market.  This is actually far worse for home economics because we usually DON'T drop any costs when we drop income. When we loose a job, yes we drop commuting costs as a 'cost of sales' equivalent, but very little else.

Also though there are far more subtle effects of the big fulcrum of falling income. A small drop in income can then grossly affect our cash flow, because it tips it into negative. That 5% "profit" we made or near break even situation we were in, suddenly leads to negative cash flow and more interest costs and perhaps a seeping level of debt which is going to drag us down over time. Remember those happy wave crests being reduced down to a low, negative, heaving swell of negative cash flow?

A bad fulcrum effect from down sizing job, maternity/paternity leave, period of unemployment etc can mean we run negative cash flow so long, that we not only have a sizeable monthly mimimum credit payement but also we run flat out of credit, and on this lower family income, have no access to more, or cannot make any more minimum payment thresholds. It gets down to a few gritty dollars a month.


Now I am getting nearer to the crux of the matter. What we have to pay for out of our 'gross margin' is for everything nice in our coseted western lives. Going out, holidays, clothes and usually for most of us, monthly consumer credit payments. We also have a lot of other stuff we get involved with or think we just "must have" on a monthly basis. Gymn memberships, magazine subscriptions, home cable / satellite entertainment, health supplements, home delivered food or wine.

Here is the point. Any single cost on its own looks small, laughable compared to the "benefit" we will get from it. The enjoyment, the life enrichment, the fitness, the relaxation. However go back and look at your Gross Margin (GM). For a pair of yuppies, DINKYs, then often they will have a pretty large gross margin. Many though have as high or higher a gearing to credit and house loans as people on the bottom of the salary scale due to urban housing costs. Some yuppies are designer nightmares, holidayholics and shopping mad. They spend a very high proportion of their gross margin on the trinkets and conspicous appearance nights out that mid to high earning yuppies make. So they have a monster good GM often, but have a terrible spendthrift attitude to cash-flow.

 At the other end we have people on low income who have little GM, and every other non essential cost eats away at it until they are on the most basic food possible and going to their parents to eat in the week up to pay day.

Avoiding any spreadsheet screenshots, but to give illustration:  A family income is €$£2000 after tax per month, and they have a steady mortgage payment of 600, and food outgoings of 600 and energy bills of 200, and commuting costs of 200. That means they have a gorss margin of only 400 dollars. That is their discretionary spend. Suddenly a his an hers gymn memebership of 75 bucks eats up almost 20%, a fith of what they have to spend. Magazines, megabroadband and net flix take that to 35%. Going out, well you know that is a must for folk without much per month? Another 50% points ?Visa payments are then what is left over, covering the minimum payment demanded very often as you can start to see. As with calories and the waistline, it is the extras we 'must' have that eat away ar our real ability to get ontop of debt and ride out any storm.

Every 50 spondoolics is then a major chunk of your discretionary income.

The majority of educated workers who give a damn about reading this type of blog, have pretty reasonable gross margin in their households. Some yes live in metropolitan areas and have either stretched themselves to get a mortgage, hoping capital gains in property value will save them from two or three years of negative cash flow. Many of us do take on way too much risk, accepting a leverage to income via mortgage any business would shy away from as very unconservatibve and crazy risky. However many of us enjoy promotion, or inheritance and so on too. But once again though, are you actually able to cover all your costs and get a gross margin even to pay for food and commuting from your housing costs?

Short Term Austertity in the face of Rank Consumerism

Back to nibblers for the most of us who have not stretched ourselves on huge mortgage leverage. We have all these nibblers and worse, we like to treat ourselves to things as soon as we are in a new job, or get a payrise, or worse, buy a new, bigger, house. We immediately put our selves in cash flow danger. Subsrcriptions, hire purchase and credit cards delay payment to get that cash off us, and it is still early cash tos to speak in the bigger picture of healthy cash flow.

Healthy cash flow, with that big ocean roller of a wave of positivity, takes months to build given we have an average gross margin. It means that we have in effect saved cash aside to let the wave build up in height. Small businesses often aim to have three months turn over (sales income) banked after several years in operation, because then they can either weather a storm, or use their credit rating to expand. It is recommended by many personal economy 'coaches'- I would like to see their bank balances, the majority of US citizens have less than a thousand dollars in savings. A more realistic goal is to have three months of your essential costs, because that is about the time you may need to get a new job, or organise longer term credit to cover for some accidental damage or ill health. Your credit limit should be reserved in fact, over time, for such emergencies and never used to pathc over a persistent negative cash flow ( as I know to my discomfort!)

Marginal Gains 

This is by no means a new concept in business or home economics, and probably not in the world of sport where it has been a recent buzzword following team Sky's huge british success in cycling. With money it means good old Aberdonian penny-pinching. Purchasing pros like myself should be very concerned about penny pinching in, but more often than not we have sales and project managers wanting to 'bring forward' income and delivery early, thus making the cost higher. This is the same as treating yourself before you save up a bit of that nice, big wave.

It takes top leadership to permeate a company with this concept, such as Martin O'Leary did with Ryan Air. He was perfectly serious when he asked Boeing if they could make a plane a few hundred of thousand of dollars cheaper by not installing cabin windows. It was a small gain, but if you make many small gains in your fixed or variable costs then you suddenly have a healthier bottom line. They have become the most profitable airline in Europe, and brought down the cost of tickets at the same time. No one else had this philosophy of every small thing counting in reducing costs or charging the customer a litte extra for those little extras.

Every little bit accrued from marginal gains though must go right to the bottome line. So if the first plane wihtout windows would be an expensive prototype, drop it! Next possible cost which can be reduced with no real internal effort. Next vendor who can be squeezed down. Next route which only makes 7% instead of 9% profit is dropped.

So for every nibbler you can get rid of in the 'early' phase of a new cash-flow scenario, the better. It is about postponing pleasure. Also as I mentioned above, it is about putting credit reduction in a san essential costs, at a far higher level than your minimum payments.

Another marginal game which pays off over time, is to move away from interest only mortgage as soon as you can, and opay even a small amount of capital per month. In this way you make a greater pay back when you sell the property, or avoid negative equity putting you in much higher debt perhaps if you are both licky to have paid off a lot and unlucky to experience negative equity when you must sell up.

Quantum Gains

On the opposite end of the scale there are quantum gains. These come about by rethinking your life and costs, income balance.  Firstly, a very big cost which is exposed to inflation and gives you a poorer quality of life is commuting. Longer, higher. You can then solve this only really by moving yourselves or moving your job. This can mean being a home working, self employed consultant for your current employer, knowing you are more disposable but saving enough to have a mega good cash flow for new business shoe leather time. It can mean moving to a city centre neighbourhood which is affordable yet being gentrfied by the hipsters and the NYPD. It can mean moving closer to faster, cheaper transport routes on the other side of the suburbs. Or like us, fuck the city, houses in rural areas are so much cheaper than we can work in refuse and kindergartens and afford a better home and nice lifestyle.

Quantum gains in income can be from promotion for example, but you should not consider capital gains as quantum income gains unless you invest them wisely and get a steady ROI on the go. If however you decide to downsize in property or location, then yes, that capital can be released as a supplemetn to income, or pay for a larger deposti on a house.

Going self employed is these days for the average worker, the best way of getting a hike in income, while of course it takes time and savings to be able to do so. You need a good wave of cash for the household while also investment money for equipment and possibly staff and premises.

One thing some hipsters and ageing yuppies with kids get trapped in though is down sizing their working hours or top line income, without significantly reducing their urban lifestyle costs. Usually this is funded in fact by credit, and often by that seeping form I talk so much about above. Little by little the credit bills rise and the total amount reaches as much as you can or should borrow for sustaining the unsustainable life style you have.

Pre Tax Income Equivalency to Scare You

Here is another way of looking at luxuries or small nibbling costs. We nearly all have an annual salary quoted pre tax. On average in the western world we pay about a third of our income in central and local authority taxes. Now think of that left over Gross Margin money again: a fifty dollar expense is actually seventy five dollars top line quoted income, and 900 dollaroos per year. Take two such expenses plus say a magazine subscription and you are spending 2000 dollars of your top line income on fluff.

 Also think of this when new costs are in the picture- commuting included. A new job on the other side of town pays better, but costs are an additional  600 dollars pcm. That is the same as 900 dollars income, which is that you really should be earning $10,800 extra gross income per year to cover this cost. Could you rather have worked ovetime in those extra hours you commute, or taken an extra part time job in a local shop, bar or warehouse ?

It is always down to making a better bottom line though through marginal gains for the majority of people in work, and building a positive cash flow scenario which is robust, while having reserve consumer credit for unforseen emergencies, not to tide you over to the next paycheque, be that $2000 or $20,000
Big gains in life are for those who dare do something about it, but anyway after a gain is made, we can soon revert to being spendtrhift and spoiling ourselves with purcashes funded on the never-never, or first month free marketing lures. We cut our cloth to match our suit - that image we want to show the world, or feel we deserve.

 We need to take a couple of months of personal austerity in ordinary times, with normal income and base costs load in order to come out ontop of our cash cycle. Cut out those nibllers , don't treat ourselves to anything special, cancel those subscriptions. Be tough when the sun is shining, in order to build that wave up so we crash over the troughs and don't get drowned in them .

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