I met a couple recently for a financial review and the reason they reached out for help, was because they had a cash flow problem. You see each month they were overdrawn, and whilst the amount varied every month, they just couldn’t identify where the problem lay.
And this is a common feature I come across all the time with individuals and couples – they don’t know if they have an income or spending problem that is causing this issue each month. And I don’t immediately know the answer either, but I can quickly identify what and where the problem is once I review the results of a budgeting tool I ask them to complete. This is the starting point, by the way with anyone who wants to get in control of their finances each month.
And when this couple completed this exercise, the amount it was able to identify was that there was on average €353 more going out than was coming in each month.
Anyone whoever completes the monthly spending planner I give them always remark how shocked and surprised they are with the results, but when they see it written down, it begins to make sense why there is a blockage at the end of the month.
People also make the mistake of looking at one area in isolation, like food shopping for example, because it is a big part of their outlay. They wonder how there is a problem because they don’t overspend in this area, but it’s their cumulative spending that’s important because when you add it together with everything else that’s the number you are looking for.
Before I continue let me give you some background on this couple because some might think they were under pressure each month because they were big spenders, who were buying lots of clothes, eating out all the time etc. because they weren't, they were very normal. Yes, there was leakage in some areas but nothing out of the ordinary.
Okay, some important numbers and facts for you to know about them:
- Both are 40 and have two children, aged 5 and 8.
- He earns €30,000 net each year.
- He was self-employed and has seen his income reduce significantly in recent years as a direct result of overseas competitors being able to sell a product he sold as well, at a much cheaper price.
- She works in a large pharmaceutical company because she has to. She wasn't always working but had to return to work when her husband’s business took a nose dive. She earns €2,700 net each month.
- They have €20,000 in savings
- Their mortgage repayment is €1,460 each month
- They have monthly debt repayments of €462
- They save €400 each month into two pension schemes. They have saved c. €55,000 to date between them.
- They save the €280 they get each month from children’s allowance into a savings plan for their two girls. This is earmarked for their future educational costs.
- We calculated they need about €2,300 each month to pay for food, insurances, utilities etc. after they paid their mortgage, saved into the pension and regular savings accounts.
Now immediately you might think stop saving into a pension and regular savings account and cash flow problem solved. And you would be right, it isn't difficult to see that, but if you left it at that and followed through with this short term solution, they would be doing serious harm to their finances in the medium to long term.
And many people solve their problems this way because they don’t realise the impact this will have on other areas of their finances. And they do this, I think, because they don’t know what they are, but if it was pointed out to them what impact it will make, maybe they would choose a different route. And this is exactly what this couple thankfully did.
With that in mind, let’s look at each of the different options open to this couple to bridge that gap for them, and I could think of 7 for them.
Earn a higher salary
This is what they thought was the answer to their problem. They needed to earn more each year. And it was him in particular who felt he needed to earn more each year.
And in order to bridge the monthly deficit of €353, either between them or from just one of them, they needed to earn an additional €4,244 net each year.
And was this possible? For her it wasn’t at the moment, because she was at her income earning limit for at least another two years. She was doing some courses that would improve her income earning ability but it would be another two years’ before that would be realised.
He was earning €30,000 net per year and it was a struggle, so he thought the solution to their problems was for him, to follow in the footsteps of his wife and go work in a factory.
I asked him how much he would need to earn each year to match what he was currently earning. He didn’t know so I told him he would need to earn €43,000 gross and was that realistic for someone who had no qualifications/experience etc. at anything other than what he had being doing since he was 18?
From my very limited knowledge of what the market was paying new entrants to manufacturing jobs, I thought it was going to be a stretch for him. And I knew of many people who had years of experience and many qualifications who weren’t earning that salary each year, so it was going to be a big ask.
And even if he was able to secure a job that was paying that amount, would he be able to adjust to working for someone else? He had been his own boss for the past 22 years, and it would take quite an adjustment I thought, not having that freedom of making decisions for yourself.
And here is something that he didn’t think of and that was working in a confined space.
You see he was used to working outside all the time and he really liked that. It was the one part of his job, that he really liked and kept him sane when his income came crashing down. He hadn’t thought about it and he took this part of his job for granted but when we were talking this through with him, he realised, that yes he really like working outside and yes it would be difficult not being my own boss.
If he had to give up doing what he did because he would financially be better off working for someone else, that was a choice he would have to make, but he would be lucky to earn an income that even matched his existing one so in a best case scenario his financially situation would stay the same, and worst case I thought he would become very unhappy quite quickly.
I think after our conversation he had a much better appreciation of his current job and it wasn’t as bad as he thought – yes his income reduced significantly, but there were some great things about it that he had forgotten about and needed reminding of.
Our chat gave him a second wind so to speak because he became more enthusiastic and determined to rethink his business and began looking at ways of re-inventing and growing it.
And it’ amazing what breaking down a number can do for your finances. It makes things that once seemed so big and overwhelming easier to achieve, when they are broken down into smaller more manageable chunks.
He didn’t know how much more he needed to earn but now he knew it was €353 each month. That was an extra €82 he needed to earn each week and was only an extra €12 a day – could he earn that much extra? Damn right he could and I have no doubt will.
The truth of the matter is that your financial situation is not dependent upon how much money you make, even if you think it is. It really depends on how well you manage the money you already earn.
Reduce Monthly Outgoings
The key to successfully managing your finances and achieving your financial goals is to live below your means but within your needs.
Let me explain what this means in real terms - living beyond your means is spending money you don’t have. And living within your means is cutting your expenses/outgoings so that you have money left over at the end of the month.
People live beyond their means by the way because they are living, in what was for a brief moment at this year’s Oscars, best film – La La Land.
They want to spend money on holidays, cars, clothes etc. but they need to be earning earn about €20,000 more than they do. They are ignoring their financially reality which leads them to overspend and getting into savage debt.
So, the lesson learned is you have to start letting your finances rule your lifestyle, not vice versa.
And you have to be brutally honest with yourself and do a warts and all assessment of what you are spending your money on each month. It doesn’t matter how big or small an outgoing is, include everything. And once you know what you are up against, you can review and tackle the areas you are overspending on or not getting enough value with i.e. insurance premiums.
The couple I was working with needed to reduce their monthly outgoings by €353 each month and was this possible? The answer was yes.
First off, they were paying €45 more each month on a mortgage protection policy than they needed to.
Secondly, they were spending €220 per week on food. And when I compared them to others of a similar age, income and family profile, this amount seemed a little on the high side, but not by much.
I asked them how realistic they thought it would be, if they were to reduce down this outlay by say €30 per week. And they didn’t know the answer to this but they agreed it was worth trying.
I suggested they set up a separate account and deposited €820 into at the start of the month and use it exclusively for all of their food expenses for the month ahead. By doing this, it would force them into making that amount last until the end of the month, and of course it could also highlight as well that the €950 they were spending was fine, and couldn’t be reduced at all.
But if they didn’t try they won’t know what the optimum amount is and whether they would be successful or not.
They tried it for a couple of months, and were successful and came under budget for both months and they admitted they saw no change at all. The only difference was that there was €120 left in the account at the end of the month which wasn’t there in the two months previous.
So, in those two areas, they were able to save without any difficulty, €175.
They made a couple of other minor adjustments to their outgoings, adopted the cash envelope concept and saved a further €200 with zero impact to their quality of life.
They achieved this with a little help from us – we just gently guided them to the areas they needed to focus on and they did the rest.
If we were to compare having to earn more income versus cutting back on existing outgoings, the amount required was the same for this couple i.e. €353 each month.
Sometimes people make the mistake of choosing one over the other, thinking that because the numbers are the same, whatever option they choose will have the same impact as the other, but they can be wrong.
Let me explain.
If they decided to bridge the gap by earning an extra €4,244 per year (€353 x 12), that is after tax income. They first have to pay income tax, prsi and USC on this earned income. So, if their average rate of tax is say 40%, which it was for this couple, they would have to earn €7,073 to net down to €4,244.
So, for every €1 they earn they only get to keep €0.60c.
If, however, they were able to save €1 from their outgoings, the amount they benefit and get to keep is that full €1.
With that in mind, if you were looking at bridging any deficit you think exists, you should first review your outgoings and identify the areas you can cut back on and or get better value on, because they will have a bigger impact than the extra money you have to earn.