Budgeting and Cash Flow

Budgeting and Cash Flow

Budget Scenarios

There are 3 types of income models: Employee income, the entrepreneur or gig worker, and the retiree or investor. The employee budget has relatively stable revenue but may have variable expenses. The entrepreneur has unstable revenue but can have stable expenses and would create a budget focused more on expenses. The gig economy worker, contractor or a holder of multiple part-time jobs can also use this model. The retiree, investor or fixed income scenario has stable revenues but may have to be more active in how they are managed and has more stable expenses. Many people have aspects of all 3 income models and they can all be combined at different stages of life or in different circumstances.

Employment Income

A worker with a full-time job and a predictable salary and benefits is a common profile, making up more than half of all adults in Canada. The revenue part of the equation which is the mandatory deductions and optional deductions are predictable and so the revenue part of the equation is straight forward. The expenses are where the work needs to be done because the lifestyle will determine where the remainder of the money goes.

Entrepreneurial, Contractor or Gig Economy Income

The entrepreneur has two major differences versus the worker. 1) The cash flows are unpredictable, so the value of doing a budget over a year becomes more important. Cash flows tend to follow a feast or famine trend where you may perform some work and not get paid for a long period and then be flush with cash at a certain time of the year. 2) The second major difference is that there will be business expenses as well as personal expenses which will often overlap. One tip of major importance is to itemize the business expenses separately from the personal expenses. If there is overlap such as a home office, automobile use, or utilities, the expenses will be there regardless of the business, but the tax implications and maybe the usage will be different between having a business or not. Why separate the business expenses from the personal expenses? Your budget will answer 2 questions at the same time: How is my business doing and is it worthwhile to keep doing it? Above and beyond my business, how are my personal expenses and are they being covered? A bonus feature is that taxes will be easier to calculate with a budget set up in this way.

Note that if you rent properties, this can be treated as a self-employed type of situation, except that there are no CPP or EI deductions because renting property is considered passive income. The budget aspect would be identical otherwise.

If you collect HST as a self-employed person, separate HST collected and HST expensed as the money comes in. This money is not yours and will have to be remitted to the government so assume that you are just holding it for someone else. You can technically use it as a short-term loan but would then have to replenish your account when you remit your HST.

If you have a business, keep in mind that some people may not pay their bills even though the work is completed. If this is common in your business, you may have a budget item for “bad debts” or non-collectible payments which would reduce your revenues or budget income.

Always think of your cash flows on an annual basis where some months have low cash flow and other months have high cash flow. During the high cash flow months, allocate enough money to cover expenses until the next period of high cash flow. How do you know if your budget has any surplus? You generally will not know until 1 year has passed and you have witnessed the variable cash flows and seen the results. The bedrock of the budget is your expenses.

Reserve Fund

For dealing with uncertainty, a reserve fund becomes more important than for those receiving stable income. For a full-time job holder, the reserve fund is designed to cover large unexpected expenses and job layoffs. For the entrepreneur, the reserve fund must also cover the low cash flow periods because work can come and go at any time, and customer payments can be variable even when the work is steady. The reserve fund acts as a buffer to absorb periods of low cash flow and should be replenished when there are periods of high cash flow. An alternative to handing this is to use a line of credit or some other means of debt. You would draw down or expand the line of credit balance during periods of low cash flow and then repay or pay down the balance during periods of high cash flow. This can be a good solution if there is no money available for a reserve fund. However, there are 2 issues with doing this. Debt usage always has an interest charge which is an added expense that provides you with no benefit. Secondly, you are at the mercy of the lender. If interest rates rise, fees rise or lending becomes restricted, you will have issues meeting cash flows when you need money the most.

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