Monday, February 23, 2009

Our focus - Incomes less Expenses

This magic equation never fails. This is the ultimate truth of our financial well being

Incomes less Expenses = Resultant Surplus.

At the end any surplus money that we have in hand is always the result of our incomes exceeding our expenses. Some may say that they do have money in hand but that comes from borrowing. This series of posts have not taken “borrowings” as a means of cash inflow. I have stuck to “conventional wisdom” or a “conservative approach” if you will.

These resultant surpluses do not automatically become savings. These have to be managed for them to become savings. A person or family having a surplus could

- Save and invest, or

- Spend the surplus away on consumption, or

- Use this for asset acquisition, or

- Prepay debts taken earlier for any purpose.

Each person / family would, presumably, choose any of the above options in their best interest and depending on their financial position. I am referring to option -2 above. It is not necessarily irrational to choose spending especially if surpluses have been adequately put aside and built-up in the past.

We eventually need to build our understanding on how to manage our surpluses. This is in essence the core of “Financial Literacy”.

A note on borrowings:

Easy borrowings to facilitate spending, fortunately has not been a part of the larger Indian psyche. It did make its presence felt mainly in urban areas and amongst youth but thankfully has been a restricted phenomenon. The growth rates in “loan products” has seen a phenomenal rise in the past decade or so but the absolute figures still seem in control.

Borrowings, however, have been accepted as a norm to finance asset acquisitions like buying a house or car or some other assets. The best part is such borrowings never run their full course. People tend to pre-pay their loans and be debt-free. A normal fifteen year home loan has an average life of just seven – eight years.

This shows the general aversion of an average Indian to carry debt in his name and a sense of shame attached to inability to repay or repossession of the asset acquired out of that debt.

I also think, the spectre of slowdown, job losses and loss of confidence in sustainability of one’s income flow has in the recent past slammed the brakes hard on free spending. One can sense a general tightening of belts and postponing non-essential expenditure.

Some interesting links for those interested in further reading:


We shall examine the basic principles of money management and how our surplus money may be handled.

Sunday, February 15, 2009

”Expenses”……Further Insight

We have seen that expenses are continuous and irrespective of our incomes tend to be more or less fixed unless some event acts to “shut the tap” so to say.

Why do people spend their money the way they do? This is a fascinating subject of study for all behavioural scientists and more recently to all followers of “Behavioural Finance” too. Is there a link between our spending habits and our mental make-up? Whilst the new sciences do believe that there is a definite and deep link, many rationalists would pooh-pooh this. Their theories are based on a presumption that a human being is a rational person and all financial decisions taken are rational and in their own considered self interest.

Do we see this playing out so simply in real life?

I had shared my observations in the previous posts about how one’s upbringing, amongst other factors, influenced the approach and attitudes of people. This and its link to their financial position or more specifically to income earning capabilities are widely seen.

Similarly, one’s unique conditions in life and upbringing, education, values, amongst others, influences how one handles money earned and spends it. Other factors that deeply impact our spending are those relating to family. Large/ smaller joint family units impact in different ways. Independent nuclear units may have more moderate expense budgets whilst those with elders would necessarily mean larger outlays.

A modest background in childhood may manifest into a moderate expense outlay later. Yet, another family with a similar background may develop a need to spend much higher so as to be seen as prosperous or “accepted” if you will, in their peer group. At the same time a wealthy family may live simply and not feel the need to spend beyond their requirements.

To cite some examples (I have tried to eliminate subjectivity to the extent possible). A double income family believes that eating outside every weekend is a good way to spend quality time with the kids and gives every one a break and a change. Yet another family would eat at home believing that was the best way things were done.

Result : Expense levels are different.

Another example – a family subscribes to one English daily newspaper and a couple of magazines. Another requires two English dailies, one business daily, a regional language newspaper and a few magazines, one of which is an international magazine.Result: Expense levels are different.

Let us take an example of asset acquisition. One family with staying in their family home or a house that has been a legacy/gift is on a different level, whereas, another family with similar income levels may need to take on loan commitments to acquire a house for themselves. Result: Outflows may be different affecting the surplus in hand.

Why are there such differences?

This is tricky and definitely more complex. You will see here that apart from levels of income, many personal and social factors leave their influence and contribute to unique spending habits. It is not the objective of this post to analyse any type of behaviour and pass judgment on the desirability or otherwise of such behaviour.

Our study is to understand that at the end of the day, Incomes and Expenses eventually determine the quantum of surplus that one has at hand. Our effort to increase financial literacy is directed towards understanding how this resultant surplus may be handled. It is, however, important to understand some of the many factors influencing financial position. This helps the person or his/her advisor get a proper perspective whilst reviewing their financial health card and in their planning exercise.

If you reflect on this, you will realize that smart marketing and product positioning is a way to exploit these vagaries of the human mind and get a person to spend. This is, however, the subject matter of another post.

We take this forward examining how this resultant surplus may be handled.

Saturday, February 7, 2009

The Second Aspect of our Financial Health Card

We have seen how Incomes and Capacity to earn are influenced by a host of many factors, including our upbringing, attitudes and the like.

In this post I will discuss about the outflow of money on account of expenses.

Whilst Incomes are largely steady and fixed for those employed and lumpy and at uncertain intervals for the non-employed category, expenses without exception are regular month on month with spikes large or small.

It is an eternal truth that money has a velocity and flows in a cycle continuously changing hands. The flow is inevitable, only the velocity keeps changing.

This flow of money in the economic system broadly represents income for the recipient and expense for the spender.

Incurring an expense is the act of spending money to get goods, services or satisfaction in return. Let us delve a little deeper in this. Expenses (including expenditure for the technical minded) can be divided as follows

Normal living expenses

These are the day-to-day expenses that are necessary for living in the current day and age. These would cover expenses on food, clothes, rents and taxes, electricity, conveyance, education, health, communication, information.

Such expenses are relatively inflexible and we have to incur them in order to live (more dramatically – survive). Even here where we presume relative inflexibility, we find that depending on income levels and propensity to spend, expense levels will vary across different strata of society.

Asset acquisition

It is always a dream to have one’s own house and in India, this is a great life time project. I will classify house buying as key asset acquisition expenditure.


These are expenses on goods and services which are not in the “Must Have” category. They can be classified as “Nice to Have”.

Let me try and give an illustration…….A foreign vacation is a discretionary expense to one while a visit to a movie at a multiplex could be a painful (and therefore discretionary expense) decision for another.

Simply put, these are expenses which may be postponed if you choose not to incur them. One has to think before committing to these expenses.


These are normally associated with health problems, accidents, sudden unexpected events (travel on account of death of a near and dear one) and therefore unplanned and unforeseen.

If you observe closely, three of the above are not water tight silos and expenses are not rigidly classified under each.

Depending on the level of income and other factors many expenses will move from being Normal Living expenses, Asset Acquisitions and Discretionary. I presume that food and other survival expenses will never be classified as a discretionary expense. However, to a family which has “Chapatis” for breakfast, the decision to have corn flakes will become discretionary.

Similarly, buying a car may be a normal living expense to a professional/businessman earning say Rs.50.00 lakhs per year, asset acquisition to an executive earning Rs. 15.00 lakhs and discretionary to one earning Rs. 5.00 lakh per year.

In this post, I have explored the basic nature of “Expense” and attempted a broad classification. My next post will take this further and examine “Expense” further from a different perspective.