Part 2 of this series is all about how can you can know your numbers through different layers and categories that will help you prioritize and simplify the process. I always break down expenses into 3 or 4 large categories. Theses large categories will allow you to prioritize what expenses need to be paid (like rent and monthly bills), what expenses you can cut (like buying a round of drinks for your friends) and give you a way to wrap your head around your numbers. Otherwise all your monthly expenses are just swimming around in your brain without a hierarchy when the inevitable happens - some months you have to decide between what expenses are more important than others.
Fixed expenses (aka living expenses)
The first category is fixed expenses. These are for all your monthly expenses that you need to pay to meet your minimum obligations for your normal living expenses. More often than not, these expenses are generally the same amount each month, hence the term fixed expense, since they are fixed and don't change very much. Examples include your rent, cell phone, utilities, car payment, internet and cable bills.
Here's a caveat to consider: Some of your fixed expenses might be variable in the amount (like how much you spend to fill up your gas tank each week), but fixed in the sense that it's a regular cost of living that is necessary for you (like groceries).
So although the term fixed sounds like any expenses that isn't variable, it really means what your normal living expenses that you need to meet each month. Once you know how much your fixed expenses are, you have a pretty good idea of what you need to earning to meet the bare minimum of your immediate obligations. This helps you prioritize every dollar you earn after.
Here's what we include in our fixed expenses category: housing, food transportation, medical and insurance.
Discretionary expenses, on the other hand, fluctuate or vary month to month depending on your habits - you have more discretion with these expenses - hence the name. This category would include things like clothing, entertainment, vices, hobbies and travel.
Something to consider: If you are married or share expenses with your partner, what you might consider to a fixed expense, your partner might consider discretionary. It's important that you can talk it through with your partner so you can understand where each of you is coming from and find a middle ground.
Here's what we include in our discretionary expenses category: shopping, entertainment, travel and personal growth.
If you aren't making money, you probably don't have ancillary expenses. These expenses often inevitably increase when you make more money. For example income taxes, savings and investments and professional service fees to attorneys or advisors who help you manage all your lovely wealth. And when you have less income or maybe no income coming in it all, ancillary expenses are reduced by default, but can also be reduced by design. For example, reducing charitable donations, gifts, professional fees or reducing your contributions to your retirement savings account in times where income is decreased or less predictable.
Here's what we include in our ancillary expenses category: taxes, loans, savings, investments, gifts, donations, professional services.
If you're a business owner, you should know what your monthly overhead business costs. This is definitely part of knowing your numbers. How you break this up is up to you. What I mean is, you can include business expenses in your fixed expenses, but I recommend creating a separate business budget. Monthly overhead is a lot like Fixed Expenses and everything else could be discretionary and/or ancillary.
After you work through knowing what your personal numbers are, you have a pretty good idea of what your salary requirement is and that will help you understand what your business needs to be earning so you can pay yourself.
Part 1 and 2 were all about mental framing. Next week in Part 3, we'll get down to the nitty gritty.