Congratulations, You’re A CEO!
Just about everyone comes to a point at sometime in their early adult years where we officially become “on our own.” By this I mean the day when “The Bank of Mom & Dad” closes your account & you’re expected to make your own way in the world. It’s the time when a person assumes 100% (or at least close to) responsibility for all their financial affairs.
Different people experience this at different times in their lives depending on circumstances. For some, this comes around age 18 usually after high school graduation, for others it may be after 2-4 years of college, while others may be supported by their parents through graduate school & beyond. No matter the timing, the principles for succeeding in your ability to manage your personal finances successfully are the same.
For me, I suppose I began becoming financially independent at age 18 when I went to college. Certainly I was responsible for some of my own finances during my college years but I was fortunate to have parents that helped with the college bills so in reality I wasn’t totally out there on my own until I finished college at the age of 22.
I accepted a job offer in Chicago during my last semester in college and was all set to move to the city after spending one last summer in Bloomington. I got a packet in the mail one day from my soon to be new employer with information about salary, health benefits, retirement plans, life insurance and a host of other information. I remember being completely overwhelmed reading through this material the 1st time since I didn’t understand half of what I was reading.
So, I took that folder of information and hoped in the car to drive to Atlanta (well, to be completely honest, I think Phish was playing in Atlanta that week too). It was time to talk to dad and figure out what all this meant & what I should be doing to prepare to start this new career I had waiting for me in Chicago. I’m sure glad I made that drive, the lessons I learned over the following few days in Atlanta would serve as more valuable than most of what I had spent 16 years learning in school.
Now, it’s been 11 years since that trip so I don’t remember the conversation exactly but it went something like this:
Me: “Dad, so I got all this salary and benefits information from my new job & I’m kind of confused by a bunch of this stuff. Do you think you could go through & help explain what this stuff means?”
Dad: “Sure I can. Go get your stuff. By the way Mark, Congratulations, you’re a CEO now!”
Me: “CEO? What are you talking about dad?”
Dad: “Well, from here on out, you are in charge of your finances. It’s your responsibility to pay all your bills on time & make sure you have the money to cover those bills. That makes you the CEO. The buck stops with you!”
I always thought that was a good analogy. It really is up to each and every one of us to take control of our financial affairs & we are the boss. The conversation with dad then continued as we started to discuss the starting point to getting your finances in order.
Me: “So, where do I start with all this sh.., err umm., stuff then?”
Dad: “Mark, there’s an old saying you may have heard before that applies to this situation: ‘If you fail to plan, you plan to fail!”
Me: “Ok, I’ve heard that before but what do you mean?”
Dad: “Well, when it comes to your personal finances, your ‘plan’ is your monthly budget of your income vs. expenses. You need a plan of how & where your money will be spent each month. Without that, you’ll never get ahead Mark.”
Me: “OK, sounds good. But I don’t know exactly what my paycheck is going to be so how can I even make a budget?”
Dad: “For now, we can make a best guess, then you can refine it to actual numbers once you get your 1st paycheck & know the exact amount.”
That was the 1st important lesson about personal finance I learned. It all starts with making a budget & sticking to it. It’s sounds easy & writing out a budget actually is quite easy. It’s the sticking to the budget part that is tough and requires diligence & personal responsibility.
Determining Your ‘Revenues’
As my dad & I went through writing out a budget for the start of my new professional life in Chicago, I learned that writing out a personal budget is not very hard & as a benefit once you understand how to write a personal budget you can write or read and understand just about any corporate or government budget document & understand what it is telling you. In the case of a personal budget, your “Revenues” are simply your income or paychecks that come home every month. This is money you expect to receive for your services over the course of the month.
So, the 1st thing to figure out is how much money you will have coming in from month to month. For most people, the money coming in is in the form of a paycheck from a job. Now, people’s circumstances vary widely but you should count as income any money you have coming in regularly from month to month. Whether it is a paycheck, rental income on a property, maybe you’re retired and collecting social security or a pension check monthly from a job. These are all items that should be included in your budget plan. For purposes of the examples I am providing, I am only going to focus on paycheck income since this is the most common form of income people acquire.
If you’re already working in a job, this is easy to figure out. Simply look at your last 1-4 paychecks depending on how often you are paid by your employer and determine how much money you have coming in each month.
(Note: If you do not work in a job that includes a regular paycheck, look back over the previous 6-12 months and figure out a conservative average of what you think you will make in the coming 6-12 months & then divide that amount by the number of months to get your estimated monthly income)
In the example I will show for the remainder of this blog, I am going to assume a single recent college graduate (if you’re married, simply figure both incomes combined) starting a job making $40,000/year. Hardly what anyone would classify as rich but not living in poverty either. We’ll assume the person receives their paycheck every 2 weeks and is thus paid 26 times per year.
This type of pay system is quite common. Most jobs pay employees either bi-weekly or twice a month. The unique nature of a bi-weekly paycheck system is that a person must budget monthly that they will receive only 2 paychecks per month but 2 months of the year, they will receive 3 paychecks. I have always preferred working jobs that pay bi-weekly simply because those 2 months a year with a 3rd paycheck function as an almost automatic addition to my savings. I’ll explain more about this later.
So, now we need to determine how much we expect our “take home pay” to be every 2 weeks. Your take home pay is the amount of money you actually receive after all deductions are taken from your paycheck for federal income taxes, social security contributions, Medicare contributions, state income tax (some states don’t have state income tax, if you live in one of those states, good for you) & benefits deductions (if you are offered things such as health insurance, a 401(k) or pension plan, union dues if you belong to a union. etc…). Basically, your take home pay is simply the amount of the check you actually cash every 2 weeks.
The 1st step to estimating the take home pay for our individual is simply to take the annual salary ($40,000) divided by the number of paycheck in a year (26 paychecks for a person paid bi-weekly):
$40,000/26 = $1,538.46
This amount is our Gross Pay. Gross Pay is the total amount of wages you earn BEFORE all the taxes and benefits are deducted. So, next we have to estimate how much our actual take home pay will be.
I personally like to use conservative estimates when I know I am starting a new job and don’t know exactly the dollar amount my paycheck will shake out to until I get that 1st paycheck. So, my dad taught me that estimating about 1/3 or 33% percent will be taken out for taxes and benefits is a good conservative estimate. I’ve almost always ended up taking home a bit higher percentage than that but if you estimate on the low end anything additional will just be extra money you can put away at the end of the month. As I said initially, once you receive that 1st paycheck you can go back & adjust your budget plan accordingly. It’s just far better to estimate on the low end for your revenues and on the high end for your expenses. If you plan for the worst case scenario, what actually happens will likely have you coming out ahead of your budgeted goals. This is a very good thing.
So, now we estimate that our bi-weekly take home pay will be:
$1,538.46 * .67 = $1,030.77
On average, we are paid 2 times a month so our monthly income is:
$1,030.77 * 2 = $2,061.54
Now, you can write out a budget on a cocktail napkin or a piece of paper but I prefer to use Microsoft Excel since it makes calculating the totals both easy and error proof. Here is how the Income Section of my mock Monthly Budget looks when this is done:
| MONTHLY BUDGET - January XXXX | ||
| | | |
| | | |
| INCOME: | | |
| | | |
| Paycheck #1: | $1,030.77 | |
| Paycheck #2: | $1,030.77 | |
| | | |
| TOTAL INCOME: | $2,061.54 | |
Determining Your ‘Costs’
Determining your income is the easy part of budgeting, determining your costs requires more effort & you need to be honest with yourself about your situation & what your costs really are. Leaving items out is not an option & is a sure road to ruin.
Classifying Your Expenses:
When it comes to your expenses, I try to classify each expense into 1 of 3 different categories:
1. Necessities
2. Debt Payments
3. Luxuries
Doing this can come in handy during times when you have to revisit your budget & cut expenses due to changing circumstances such as losing a job.
Necessities
The necessities in your budget are the basic things everyone needs in life. This includes the cost of rent/mortgage, utilities that provide electricity & heat to your residence & food which is needed for survival.
Now, rent or a mortgage is usually a fixed cost and is the same from month to month but for other expenses such as utilities & food expense you’ll likely have to make some estimates.
The easiest way to make a good estimate is to look at the past to predict the future. For utilities, take a look at your last 12 months of utility bills and determine the average you paid each month, then plug this number into your budget for monthly utility expenses (for utilities I would add a 3% increase each year since utility costs continue to rise).
Here is an example of how this would be done. For purposes of this exercise I’m including all utilities together as a single item (water, gas, electric, sewer):
| | Total Cost Of Utility Bill Paid: |
| January Last Year: | $ 129.67 |
| February Last Year: | $ 127.42 |
| March Last Year: | $ 104.82 |
| April Last Year | $ 99.76 |
| May Last Year: | $ 97.42 |
| June Last Year: | $ 94.71 |
| July Last Year: | $ 93.21 |
| August Last Year: | $ 95.36 |
| September Last Year: | $ 102.42 |
| October Last Year: | $ 109.89 |
| November Last Year: | $ 121.42 |
| December Last Year: | $ 134.62 |
| | |
| Total: | $ 1,310.72 |
| Average (Total/12): | $ 109.23 |
By looking at this we now know that last year, we paid an average of $109.23 per month to cover our utility bills. Since energy costs continue to rise rapidly, I always add an additional 3% increase to my budget to account for the increasing costs that are likely to be incurred in the coming year. This calculation is simple:
$109.23 * 1.03 = $112.50
$112.50 is the amount I will then use to budget for monthly utilities for the coming year.
You can use the above exercise to estimate any cost that is variable in your budget from month to month that you want to account for in your monthly budget. You don’t always have to look at an entire year to come up with a good average but the more months of data from the past you use, the more likely you are to come up with a good estimate.
Estimating how much you spend each month on food can be tricky but I just use a very simple estimate of $10/day for food for $300/month per person in your household. However, if you want a better estimate, look at your grocery and dining out expenses for a month or two month period and determine the average of how much you spend and plug that number into your budget.
Here’s how our Necessities Expenses example budget looks now:
| EXPENSES: | |
| | |
| Necessities: | |
| Rent: | $ 900.00 |
| Utilities: | $ 112.50 |
| Food: | $ 300.00 |
Debt Payments
One of the hardest parts of a budget to confront honestly is your debt obligations. Nobody likes debt, most of us know we need to try to get out of debt & yet for the most part this is a subject that remains in the shadows and is discussed far too little. But, you need to be honest about what your current debts are & what the minimum payments on those debt obligations are costing you & come up with a plan for eliminating those debts over time. Including an honest assessment of your debt obligations in your budget is a 1st step to tackling & eliminating your debt over time.
I’ll devote entire future blog entries to strategies for getting out from under debt & the toxic nature of credit card debt in particular but just know that if you’ve got large amounts of debt, all is not hopeless. You can get out from under those debts. It won’t happen over night but with a solid plan you can eliminate debt. And most importantly, there is no need to feel ashamed or embarrassed by the debt you’ve accrued; you are far from alone if you carry a large amount of credit card and other debts these days.
“The average college graduate has nearly $20,000 in debt; average credit card debt has increased 47 percent between 1989 and 2004 for 25-to 34-year-olds and 11 percent for 18- to 24-year-olds. Nearly one in five 18- to 24-year-olds is in "debt hardship," up from 12 percent in 1989.” (Source: Demos.org, "The Economic State of Young America," May 2008)
In terms of budgeting for debt, I recommend starting with simply budgeting for making the minimum monthly payment required on each debt obligation. When we start to talk about strategies for paying off debt, we’ll come back to these budget numbers & make adjustments. For now, the purpose is to understand your minimum monthly obligation on each debt. In our example case, I’ve included credit card, student loan & a car payment as debts. Here’s how our expenses look now with both necessities & debts listed:
| EXPENSES: | |
| | |
| Necessities: | |
| Rent: | $ 900.00 |
| Utilities: | $ 112.50 |
| Food: | $ 300.00 |
| | |
| Debt Payments: | |
| Credit Card: | $ 175.00 |
| Student Loan: | $ 100.00 |
| Car Loan: | $ 200.00 |
Luxuries
The final piece of the expense budgeting is determining the luxuries you pay for each month. Now, not everything here is necessarily an absolute “luxury”. Gas for your car & car insurance are pretty much necessities for most people to get to & from their jobs unless you live in a city with quality public transportation options and those are few & far between in modern day America. However, I like to list those items here because this is always the 1st area I go to when it comes time to trim expenses.
I may not be able to eliminate these costs but by listing them here I remember during tough times I might be able to trim these expenses since maybe I could shop around & see if I can save on car insurance with another carrier? Maybe I should go online and find out what gas station in my neighborhood currently has the lowest prices so I can spend the least amount possible on gas (http://www.fuelprices.net/ is good for this by the way).
How detailed you make your budget is really a matter of personal preference. Some common items that you might include in your budget as luxuries are things such as Cable/Satellite TV bill, Home Internet Access, a gym membership, Gas or other Transportation expenses (when I lived in Chicago I had a monthly unlimited card to ride the public transit system & didn’t own a car), Car Insurance & Entertainment expenses (I call this “Fun” Money in my budgets).
So, now we are all said & done with expenses, here is what our sample expenses now look like:
| EXPENSES: | |
| | |
| Necessities: | |
| Rent: | $ 900.00 |
| Utilities: | $ 112.50 |
| Food: | $ 300.00 |
| | |
| Debt Payments: | |
| Credit Card: | $ 175.00 |
| Student Loan: | $ 100.00 |
| Car Loan: | $ 200.00 |
| | |
| Luxuries: | |
| Cable TV | $ 70.00 |
| Internet Service | $ 40.00 |
| Car Insurance: | $ 65.00 |
| Gas: | $ 150.00 |
| "Fun" Money | $ 400.00 |
| | |
| | |
| | |
| TOTAL EXPENSES: | $2,512.50 |
Houston, We Have A Problem!
Now that we’ve listed all our revenues & expenses, we have a clear picture of what is coming in & what is going out from month to month. Here’s how our example looks:
| MONTHLY BUDGET - January XXXX | ||
| | | |
| | | |
| INCOME: | | |
| | | |
| Paycheck #1: | $1,030.77 | |
| Paycheck #2: | $1,030.77 | |
| | | |
| TOTAL INCOME: | $2,061.54 | |
| | | |
| | | |
| EXPENSES: | | |
| | | |
| Necessities: | | |
| Rent: | $ 900.00 | |
| Utilities: | $ 112.50 | |
| Food: | $ 300.00 | |
| | | |
| Debt Payments: | | |
| Credit Card: | $ 175.00 | |
| Student Loan: | $ 100.00 | |
| Car Loan: | $ 200.00 | |
| | | |
| Luxuries: | | |
| Cable TV | $ 70.00 | |
| Internet Service | $ 40.00 | |
| Car Insurance: | $ 65.00 | |
| Gas: | $ 150.00 | |
| "Fun" Money | $ 400.00 | |
| | | |
| | | |
| | | |
| TOTAL EXPENSES: | $2,512.50 | |
| | | |
| MONTHLY SAVINGS: | $ (450.96) | |
Do you see the problem here? According to our budget, we’re spending $450.96 more than we are making in income. This is unsustainable & explains why we have the rising credit card debt payments we listed.
However, don’t freak out if you find this to be the case when you write out your budget. The first step to fixing any problem is identifying the problem. In this instance, we’ve identified that we need to either find an income source that provides an extra $450.96 per month or cut at least $450.96 from our monthly expenses.
The 1st budget I wrote out with my dad when I did this listed expenses that were over $1,000/month more than what I expected to be making. I was living in a Fantasy Land where I thought I could afford many things that I absolutely could not. If I hadn’t written out that budget in advance, it would have caused a world of pain down the road if I had just started spending money on all those things I “wanted” but didn’t necessarily need. By writing out a budget, I learned what I could afford and what I could not afford today. That doesn’t mean I simply gave up on ever having those other luxuries, it was something to strive for being able to afford in the future. Some I’ve gotten to a point I can afford now, some are still on the list as wants for the future.
I’ll discuss how to fix a budget in the red in the next Blog. In the meantime, if you have any questions about budgeting feel free to post them in the comments and I’ll do my best to answer them. If you’d prefer not to post them publicly, I can always be reached via e-mail at wardoskibum@gmail.com. I hope this helps you start to take control of your finances, there’s much more to come but it all starts with the budget.
As my dad told me: “Congratulations, You’re A CEO!”
