For most people accounting is just plain boring. The thought of sitting behind a desk all day looking at numbers on a screen makes some people sick. There is a small fraction of the population that actually enjoys accounting (FYI- I’m an accountant, in case you haven’t read my About Me section =P). What the average Joe doesn’t realize, though, is that accounting can be quite useful in a person’s everyday life. In fact, accounting can actually save you money and optimize your cash flow. This article provides a few key tips on how you can use accounting in your life to make more money.
Accrue Now, Pay Later
Accruing costs is typically done by businesses and corporations to manage expenses and more importantly cash flow. Typically, expenses for a full year are accrued for monthly, based on a benchmark (i.e. prior year actual billed amount). Each month, the business owner or accounting department will set aside 1/12th the cost of the final bill to be paid when it is due, rather than incurring a large expense all at once. So, how does this relate to you? Well, many people have car or motorcycle insurance that provides the option of paying in full when the bill is due or paying monthly. Most people pick monthly because it’s more convenient, but what they don’t realize is they can actually save money by paying in full at the time the bill is due. Insurance agencies will typically add an additional fee for paying monthly to cover the cost of processing. When I’ve told people this, most of them say, “But I don’t have $600 dollars right now to pay the bill in full, so I have to pay monthly.” This is where accrual accounting becomes your friend.
Example: Let’s assume you just paid your insurance bill which is effective starting April 1, the total of which was $600 dollars. The policy runs for the full year, so it will need to be renewed again next year before April 1 in order to make sure your coverage doesn’t lapse. Using last year’s bill as a benchmark for next year’s insurance cost, you can estimate your monthly insurance payments ($600 / 12 = $50 per month). Once you have the monthly amount calculated, you can then take that amount and put it into a high yield savings account each month, which will allow you to earn the interest on that money over the course of the year before you withdraw it next March to renew your car insurance policy. The alternative is to simply give the insurance company the same $50 each month plus an additional $5 processing and service fee, so your monthly payments end up being $55 dollars ($55 x 12 = $660). By using simple accrual accounting, you save yourself $60 plus give yourself the opportunity to earn a little extra interest.
The example above can be applied to a number of everyday expenses. Some common ones are:
- Property Taxes
- School Taxes
- House Insurance
- Quarterly Bills
- Car Maintenance
My husband and I actually built these monthly accruals into our budget and then transfer the amount to savings each month. While it’s not an exact science, you are normally able to get pretty close to the next year’s bill using the prior year as an example to accrue off of. Each year when a new bill comes in, say for taxes or insurance, we update the total amount owed which then change the monthly amount we need to accrue for. It has work well for us and it’s a way to easily manage your cash flows.
The process and example noted above is also an easy way to help manage your monthly cash flows. By accruing for some of the major expenses that you may have, you also gain control over your cash flows. Rather than having to pay a larger bill twice a year or once a year, and worrying about how you are going to pay such a large amount that month, you can spread that cost over the whole year. Each month you will have the comfort of knowing that money is being put aside for that expense and it will be paid for in full when due.
Another common example, aside from the car insurance one discussed above, is taxes. Many people today will escrow their taxes when they set up their mortgage because they don’t want to worry about paying their taxes twice a year when the bill comes through. So rather than doing what I just noted above (saving on your own in a high interest savings account until the bill is due) they end up escrowing the taxes. This basically means that they give the bank additional money each month when they pay their mortgage and the bank then pays the taxes on their behalf. This sounds great and seems like the bank or lender is doing you a big favor, right? Well, what the bank does is take that additional money and park it in a savings account where they earn the interest instead of you. Then, when the time comes, they withdraw the funds and pay the taxes on your behalf, keeping the interest earned on YOUR money. Property and school taxes can be fairly high in some states. In my county, taxes can be as high as $30,000 a year for an average-sized home. If you saved that amount in a high yield account paying 1% interest you could earn around $300 dollars.
Always pay yourself first!
Do you prefer the convenience of monthly payments? Do you accrue your personal expenses? If so, what do you do with the money you set aside? Do you have alternative methods that you use?