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Imagine you have been put in charge of your favorite coffee shop. You really like their coffee, so you want to do all you can to keep it going. Could you manage it or would the shop go out of business?
While you may not have the industry knowledge to manage a coffee shop…yet, you should have the skills to manage your own income and expenses like a business. If you don’t manage your income and expenses? Then you could go out of business! Okay, that’s a bit harsh, but who enjoys feeling broke all the time, and not being able to afford the things you really want?
Every dollar serves some purpose and you need to know what that is.
Back to the coffee shop. If you did manage it, you would need to keep track of everything that came into the shop and everything that left.
You would know what cash and credit card payments you received. That is your Income. Also, you would know how many cups of coffee, pounds of coffee beans, and all the paraphernalia the shop sold. These are your sales (sort of like the hours you “sell” to your employer). You would keep track of what you paid for supplies, rent, electricity, water, and insurance. You would also know how much you paid each employee and what you paid in payroll taxes and benefits. These are your expenses. Finally, you would know what you made, which is the coffee shop income less its expenses. That is called your profit (before taxes).
What would you do with that profit? You would pay income taxes, of course. You might create an emergency fund so you would be prepared for some unexpected calamity, like a delayed coffee shipment, or a broken storefront window. If you were really forward thinking, you might even set aside funds to replace broken equipment or maybe even save up to buy a building rather than continue to rent.
What if, instead of a profit, your expenses continually exceeded income? You have a loss – ouch! You don’t want to lose the coffee shop, so you might borrow some money to cover bills. That only postpones your problem; it doesn’t fix it. So you create a budget to learn why your expenses were so much compared to income. You might hire a bookkeeper to make sure you didn’t miss anything.
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You could even hire a coffee shop planner who would tell you if you are buying too many supplies compared to what you sold. The planner would make sure you charge enough for coffee and she would tell you to stop paying that Friday night blues band that wants free coffee and isn’t actually improving business.
I’m sure you figured out where this is all going: You need to know what you make and where you spend each dollar.
If you don’t know, look at the last 12 months of income and spending, even start a budget so you see why you keep borrowing on credit cards instead of saving for your future.
In the end, there is no left over money. Every dollar needs to work for you, as hard as you work to make every dollar.