Till now we have seen about assets and liabilities. If you have not read the post you can read it here. In this post, we will discuss something that exists at the heart of any individual and is essential to balance to achieve the desired outcome for any individual. if you have not guessed it till now, this post will discuss Income, savings, and expenses.
So first of all let’s start by understanding these terms.
Income
Income is the amount that an individual or entity brings in from the work he/she/they do or from their investments. It can come from various sources such as salaries, wages, dividends, interest, rents, and profits. This is very similar to the cash inflow in the cash flow statements of companies.
Income can be categorized into different types:
- Gross Income: This is the total earnings before any deductions. The deductions here can be taxes or financial obligations. So in essence the gross income is not the actual disposable income that the person or entity has in his/her hand.
- Net Income: The amount left after all deductions, such as taxes and financial obligations, these financial obligations can be business expenses in the case of businesses and day-to-day or necessary expenses in the case of normal individuals.
- Disposal Income: This is the amount available after paying for necessary expenses. This is the amount that the person or entity can spend on discretionary items or use to invest or distribute as dividends.
- Taxable Income: This is the portion of income that is subject to taxation. The taxable income for a person or entity can be reduced by using the various provisions provided by the government.
Whether it be an individual or a company both focus on increasing their income from time to time which seems to be a sensible decision. Increasing your income helps you to get more money at your disposal. However, increasing income also comes with a higher tax obligation if not managed properly.
Savings
Savings refers to the portion of income that is not spent on immediate consumption and is set aside for future use. It represents the money left over after all expenses and obligations have been paid.
Savings can be used for various goals such as emergencies, retirement, education, or major purchases. Savings can be kept in different forms, such as cash, bank deposits, or other low-risk financial instruments. Having savings provides financial security and helps in managing unexpected expenses.
In modern-day economies savings don’t happen by themselves, it requires a conscious decision and action on the person’s side to save a portion of what he/she has earned. This is because modern-day economies are consumer-driven and the products are tailored to suit different segments of consumers leading to impulsive buying by the consumers.
Here are some effective ways to save money:
- Automate Savings: Set up automatic transfers from your income account to your savings account. This ensures you save consistently without having to think about it.
- Create a Budget: Track your income and expenses to understand where your money is going. Use this information to create a budget and stick to it.
- Use Cashback and Rewards Programs: Use cashback credit cards and rewards programs to earn money back on your purchases. This is analogous to getting a discount on items.
- Avoid Impulse Purchases: Impulsive purchases are the purchases that you make based on peer pressure or glamorous selling without accessing the actual need for the item for yourself. This can lead to overspending. Avoiding impulsive purchases can help you save this extra expense.
- Reduce Discretionary Spending: Discretionary spending is the spending that you make on items that are not necessary for your survival. If you are not able to meet your saving goals you can reduce your discretionary spending to meet them.
Boosting savings helps people to plan for future, uncertainties and boost their net worth if done properly. Savings is what is available to people for investing in assets.
Expenses
Expenses refer to the costs incurred in the process of earning income, running a business, or for the mere act of survival and personal interests. Expense is the cash outflow from the person or entity. They can be categorized into various types, such as:
- Operating Expenses: These are the costs related to the day-to-day functioning of a business, like rent, utilities, and salaries.
- Capital Expenses: These are the expenditures on assets that will be used for a long period, such as machinery or buildings.
- Personal Expenses: Costs incurred for personal needs, such as groceries, transportation, and entertainment are clubbed under this category.
In accounting for businesses, expenses are recorded to reflect the cost of operations and are deducted from revenue to determine net income. For individuals, the majority of the expenses are not allowed to be deducted apart from certain expenses. Thus the net taxable income can’t be reduced much in the case of individuals. This is done to incentivize businesses to create more employment.
As a general rule of thumb, a person can spend 50% of his income on his or her necessary expenses such as housing, food, travel, etc and a maximum of 30% should go to discretionary expenses and at least 20% should go into savings. Notice that at least in savings, reducing your discretionary expenses and boosting your savings to invest in assets can help you reach your financial goals early in life.
It is to be noted as the income of a person increases he or she can increase the savings percentage if the cost of the necessary expenses of the person doesn’t increase at the same pace and the person doesn’t increase his or her discretionary expenses till they achieve their financial goals.
So all in all increasing your income or cash inflow is not the only important thing, but also optimizing expenses or cash outflow and savings to be able to become successful financially in life.
This is all for this post. Tell me your thoughts in the comment section. Don’t forget to follow my Facebook and Instagram pages for regular updates. See you all in the next post. Till then keep learning.