Expenses and Liabilities

Financial Literacy can be defined as the ability to make judgements based on good information.  It is also the ability to understand how money works in the world; how someone earns or makes money, how that person manages it, how he/she invest it (turn it into more) and how that person donates it to help others.  Before you begin to accumulate wealth, it is extremely important that you try to fully understand money and how it operates.  Learning the basic accounting principles would be a great start.  We will explore two terms often used in accounting, Expenses and Liabilities.

 

Expenses

Expenses can be defined as the cost required for something, or the money that is spent on something.  Most expenses are tied directly to the cost of living.  I tend to break expenses down into four categories: Fixed, Variable, Unexpected, and Miscellaneous.

Fixed Expenses are those that are typically the same each month.  Those expenses would include: rent or mortgage payment, cable and internet bill, insurance premiums, car note, any memberships (subscriptions, gym, Netflix, etc.) or childcare.

 

Variable Expenses are those that will change from month to month, meaning that from month to month that expense may be higher or lower.  Variable expenses would include: water and electric bill, groceries, credit card payments, health care cost, and gas for your vehicle.  The expenses could be higher or lower depending on the time of the year, your family size, whether you travel often, or your spending habits.  A number of things could impact the amount of these expenses.

Unexpected Expenses are those that occur on occasion and at no particular time.  These expenses may be able to be anticipated, but still no direct way of know exactly when they will occur.  Unexpected expenses could include: car repairs, paying a ticket or fine, impulse purchases, money for assisting a friend or family, braces for your child, or anything else that may come when you aren’t expecting it.

Miscellaneous Expenses are expenses that we may not account for.  They are different from unexpected expenses, because these expenses normally occur, but usually not on a monthly basis.  Examples of miscellaneous expenses would be: car inspection & registration, annual IRA or Credit Card Fees, Annual Club dues, school shopping for children, hair cut or beauty salon, clothes in the cleaners, money spent on seminars, books or conferences, routine car maintenance, or taxes (depending on your situation).

  

It is important to understand each of these expenses, especially if you are working to maintain a budget or a spending plan.  Many people create their budget based on their monthly expenses but fail to account for the unexpected and miscellaneous expenses.  Depending on your financial situation, you may want to add $200-$300 or $1000-$1,500 to your budget per month, just to be allocated to those unexpected and miscellaneous expenses.  This will help give you a better picture of your financial situation so that you can see what you having coming in and going out. 

Related: 9 Tips to Help Reduce Your Monthly Expenses

Liabilities

Liabilities is something in which an individual is responsible for, especially a DEBT or a Financial Obligation.  Good examples of liabilities would include: car notes, credit card debt, student loans, mortgage loans, payday advance loans, health care bills, business loans, or any other outstanding debt.  Whether you’re an individual or a business, you typically would like to decrease your liabilities and increase the amount of your assets.

 

Liabilities in most cases take money out of your pocket, while assets put money back into your pocket.  If you are a business owner or an investor, there are certain situations where a liability could essentially put money into your pocket.  A perfect example, would be an investor taking a mortgage out for a second home.  However, since the investor is knowledgeable, he knows that he will get a great interest rate on his loan and that due the size of the house and neighborhood, he could easily rent the home out to a small family.  Based on the market value of the home, the rent would end up more than the investor’s monthly mortgage payment, meaning that every month the home would pay the investor income, although the home shows as a liability on his books.

 

Related: The Cash Flow Quadrant

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