“Do not save what is left after spending, but spend what is left after saving.” – Warren Buffett

Over the last few weeks, we have introduced several components of earning income and tried to understand the crucial position that earning income takes in our overall financial well-being. The other side of the equation is taken substantially by expense management, which we will begin to discuss today.  The relationship between income and expense at a personal level can be crudely expressed as:

 

Where, TI is total income from various sources i

OS is other cash inflow from various sources j

EX is total expenses over various outlays k, and

SVI is total savings and investmentsin m

Way back to 6000 BC, trade for goods and services was conducted through bartering, which is said to have started in Mesopotamia. It was later adopted by the Phoenicians who bartered goods to those located in various other cities across oceans. The Babylonians developed an improved bartering system. Goods were exchanged for food, tea, weapons, and spices. Salt was a particularly popular exchange item to the extent that Roman soldiers’ salaries were paid in it. Consequently, a family that needed clothes,or any item for that matter, could get them by offering the salt, or any other item they had. Coins and paper money were created in China in about 770 BC and 700 BC, respectively.

With substantial developments in cash and payment systems today, individuals and families needing goods and services would simply pay for their prices in cash or its equivalent. And because it is our reality that we need several things in life, we end up having to pay for them. These might include the groceries, domestic utilities such as electricity and water, transportation to our places of work or business, etc.

Defining ‘expenses’:In defining what expense is in personal finance, we have to be cautious. For example, if we have a mortgage loan and we make monthly payments, we may think of the payment as an expense. In reality, however, it is a part investment in the property that we took the mortgage to purchase. We will, therefore, get to the point where what may ordinarily be considered as an ‘expense’ can actually be recognised as an investment. For now, we will take expenses as the costs we bear by paying for the items and services we may require in our lives. Consequently, personal expenses are the financial costs we bear at personal and family levels.

Understanding Expense:Incurring expenses is a necessary part of modern life. However, we should derive value from expenses and minimise waste. To be able to do this, we need to have a good understanding of the following:

Types, forms and behaviour of expenses

Difference between cost, price and value

Compliance with regulation on certain expenses

Overall expense management

Knowledge about types and forms of expenses: We need to understand that there are certain core aspects of our living whose expenses we have to bear to survive. Depending on our stage in life and our overall financial situation, some aspects of these expenses might consume a disproportionate part of our income. These expenses may include:

Feeding

Transportation

Payment for utilities (electricity, water, etc.)

Clothing

Rent, which may be annual in our environment rather than monthly in other

climes

If we have school-age children, their school fees will need to be paid on a

term/semester/sessional basis

Basic home maintenance such as plumbing, electrical repairs, etc.

As important as these fundamental expenses are, they require careful understanding and attention as they may consume more than a reasonable or acceptable portion of our periodic budget.

In addition to the necessary payments we may need to make, we also have discretionary expenses to contend with. Quite honestly, there is just a thin line between what is necessary and what is discretionary. Thankfully, discretionary expenses represent a more fluid and flexible aspect of our personal spending, as they encompasscosts that enhance our quality of life and are not strictly necessary for survival. Typically, discretionaryexpenses reflect our personal values, interests, and lifestyle choices, thereby varying from one person to another.

For instance, we may have power generators in our homes and a fleet of vehicles for different purposes, all of which will require fuel and maintenance from time to time. Given our cultural expectations, we may need to or are expected to support other family members and friends. Similarly, we may make it ‘incumbent’ upon ourselves to travel on holidays or to places of worship every year. All these might not necessary be required for our survival but be a part of self-expectations to do with our feelings of self-worth.

Being financially responsible is key to finding the balance between a desire for life’s legitimate pleasures and the imperative for being financially responsible. This balance would, obviously, vary between individuals based on their income, financial goals, sense of social and economic status, personal priorities, etc. This requires continuous evaluation of choices and spending patterns, which must always align with long-term goals.

All efforts to earn income can be rendered asunder if there is no check and control on expenses. Understanding expenses and their nature, tracking and controlling them is integral to successful personal financial planning. The process will involve not just recording transactions but also understanding fixed and variable expenses, spending patterns, spending motivations, etc. Based on these, a practical expense management strategy should then be developed. We will take these up over the coming weeks.