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.


Discretionary

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.


Emergency

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.

7 comments:

Vinod_Sharma said...

Mavin, that is a very logical breakdown of the expenses that we all have to incur. I particularly liked the separate head that you given to 'asset acquisition'. This is clearly distinct from discretionary expenses and actually is non-discretionary for most. I mean acquisition of one house commensurate with one's projected station in life is as almost as essential as non-food survival expenses. Acquiring a second house/property at an appropriate time is one good way of keeping a healthy inflation-proof cushion for emergencies. I am sure there are better and more efficient ways of doing that...

Indian Home Maker said...

Valentine Day shopping would be ...??

Only shopping for a cause, for freedom and equality. ... I think it should fall under 'Emergency' :)

manju said...

Nice analysis of household expenses, Mavin!

While managing our household expenses, one thing I noticed was that the relative importance of the various items in the 'nice to have' category changed as the children grew up.

Final_Transit said...

Hi Mavin,

Good clues on managing finances. Right now for me, its only hand to mouth followed by drooling over the possibility of foreign trips (discretionary as you classified but its primary for me!)

cheers,
Priyank

Mavin said...

Vinod,

Thanks

Real estate is another avenue for investing surplusses that one may have. However, speculation in real estate could end up in monies blocked in incomplete projrcts.

Having a second house is surely a luxury to majority of the employed, a necessity / investment for those with higher surplus cash on hand.

However real estate as an inflation proof investment can get very tricky.

Mavin said...

IHM,

hahaha....I would put it as discretionary...or may be we can have a new category....Protest Buying...like what Renuka (empty vessel) Chowdhury says...Pb Bharo.


Manju,

Yes. These lists keep changing. When the kids have flown away from their nests and the two parents come to terms with their lives...the lists change again.

Sign of life as change is constant.

Mavin said...

Hi Priyank,

Totally agree with you.

For a hard core bag packer the priority is always save for the next trip and then food, stay and the rest follows.

Thums up for that.

When is the next trip and where is that....Antartica or tracing the Silk Road. :)