In tough financial times, most people would rather avoid thinking about how much things cost and whether they have enough money to cover their monthly expenses. The reason for this is usually that money issues– particularly when the issue is that you haven’t got enough of it – make people feel disempowered. In addition, many people (even those who run their own businesses) don’t have a clear sense of how much they spend every month and they sometimes imagine that problem is greater than it actually is. If financial issues are causing you concern, the worst thing you can do is adopt the ‘ostrich approach’ and stick your head in the sand. Now is the best time to take stock of your financial position – and take back control of this aspect of your life or business.
In order to determine whether your financial position is a good or bad one, you need to be able to answer three questions:
- Are you spending more than you earn?
- Does more than 15% to 20% of your monthly income gom towards credit payments (this would include credit cards, car hire purchase payments and other such expenses, but would exclude your housing bond)?
- Do you have a savings fund that could cover at least three months’ worth of your living expenses in a financial emergency? You should be answering ‘no’ to the first two and ‘yes’ to the last question. If you’re one of the people who can’t provide an answer, following the steps below will help you to develop a clear picture of your financial position – and provide you with the tools to improve it.
Step 1: Determine Your Debt to Income Ratio
As interest rates go up, interestlinked credit payments will eat into more and more of your income. Financial advisors recommend that it’s unwise (and for most families not sustainable) to spend more than 20% on credit payments. Working out what this percentage is, is known as determining your debt to income ratio.
- Identify all sources of income. As a first step, you need to determine how much money you have coming in each month. If your household has two earners or you have more than one source of income, list each of these separately. Only look at the take-home amount – that’s after tax and deductions such as UIF and company contributions to medical aid and retirement annuities.
- List debts (excluding your house). Identify each of your monthly credit payments, except for your house. This will include loans, car payments and credit cards.
- Determine your debt to income ratio. Divide the total monthly credit payments by your total monthly income. This will give you your debt to income ratio. Now multiply the figure by 100 to get a percentage – for example, if the figure you end up with is 0,2 multiply it by 100 to get 20. This figure indicates the percentage of your income being spent on credit payments or debt other than your home. If the number you come out with is above 20%, you need to investigate ways to reduce your debt.
Step 2: Track Your Monthly Expenses
Expenses can be divided up into fixed expenses (those thatm remain the same each month and are difficult to control), flexible expenses (those that vary from one month to the next and are easier to cut down on) and periodic expenses (those that you only pay once or twice a year, but that are easy to forget about). Firstly you need to know what your monthly expenses are before you can identify areas where you can save.
- List all your fixed expenses, including your house payments. This will include car, medical aid and retirement annuity (if these come out of your take-home salary), bond repayments or rent, school fees, membership fees to gyms or clubs and subscriptions, to name a few.
- List all your flexible expenses. This will include things like petrol and food costs, utilities, phone bills and entertainment. Because these expenses vary, you will need to work out an average. Record how much you’ve spent on these things over the past three months and divide the number you get by three to get an average.
- As a further exercise list all your daily expenses for a week. It’s best to write down each amount as you spend it because it’s easy to forget the little things like parking and tips, but if you find this too tedious ensure you get –and keep – a receipt of absolutely everything, and then add it all up at the end of each day or the end of the week. Most people find this exercise a real eye-opener as it shows how much you spend on the things you don’t think about, such as cooldrinks, parking, eating out and snacks. Now go back to your flexible expenses list and make sure you’ve made allowance for these incidental expenses as well.
Step 3: List Your Expenses to Determine Monthly Savings Needs
Now you need to track your period expenses. Although they only crop up once or twice a year, they’re easy to forget and usually fairly hefty, which means they can wreak havoc with your financial situation if you don’t plan for them. Once you’ve worked out what they are, however, you will know how much to save accordingly.
To determine what your periodic expenses are, go back over each month of the previous year and pick out those payments that don’t occur monthly. They might include things like repairs for your home or car, school clothes, gifts, holidays, birthdays, graduations, car licenses, special occasions like weddings, emergency medical expenses and replacement of appliances at home.
Try and work out what these might be for the year ahead. Once you’ve added all of these up, divide the number by 12 and this will give you an indication of the amount you need to save every month to cover those things not already included in your monthly expenses.
Step 4: Compare Your Income to Your Expenses
Now that you have a list of all your expenses, seen and unforeseen for the year ahead, and an idea of exactly how much money you have coming in, it’s time to answer that first question: are you spending more than you earn? Subtract your total monthly expenses from your total monthly income – what’s left over is what you have to save for a rainy day. But if you end up with a negative figure, you need to do one of two things – reduce your expenses or increase your income. For most people, earning more is considerably more difficult than spending less so try to focus on what you can control, which is reducing your monthly expenditure. Work out how much you can spend on each flexible expense item a week and keep track of exactly how much you’re spending.
Step 5: Keep a Lid on Spending
Some people find it easier at first to put the amount of cash for each item into an envelope so that they know exactly how much is left, and to stop spending once the cash is finished. Having a budget however is a much easier way to prevent expenses from getting out of control. Knowing what your past income and expenses were gives you the tools you need to create a future spending plan. Look at which flexible expenses you can reduce or cut out altogether and don’t forget to include your emergency savings fund for periodic annual expenses.
By using the following formula, you should aim to end up with a balance that gives you a surplus, not a deficit.
Step 6: Start Saving
Financial advisors highlight the importance of saving money in order to cover you in an emergency such as a massive unforeseen expense or the loss of family income. They advise that you have enough put away at any time to cover at least three months of living expenses. This will protect you from being in the situation where your family is one salary cheque away from bankruptcy. Use the surplus from your budget each month to save. It’s a good idea to put this into a separate account that you only access for true emergencies.
While the above might sound like a massive undertaking, you only have to do it once or at the most twice a year. And once you’ve done it once, it gets easier each time. It’s a good idea to assess your expenditure against your budget every few months to ensure that you have not slipped back into bad over-spending habits. And remember, it’s not true that what you don’t know can’t hurt you. So take the financial bull by the horns and get back control of the situation. You’ll never regret it.