There are a couple different ways to account for income and expenses. My favorite method for personal finance is called the contribution approach. This allows for separation of variable and fixed expenses. Using the easy to follow method I’m about to teach you, you’ll be able to figure out how to reach your financial goals. So let’s start at the beginning – what are variable and fixed expenses?
Fixed expenses
Fixed expenses are expenses which will not change period to period. You can think of them as rent or any bill that stays the same month to month. These are important because after figuring out how much your fixed expenses are per month, you can figure out how much you can afford in variable expenses.
Variable expenses
Variable expenses are expenses which change month to month. You can think of these as groceries, nights out, or any other expense which fluctuates based on usage or activity.
Mixed expenses
There are also mixed expenses which are expenses that begin as fixed expenses to a threshold and then become variable. You can think of this as a phone bill that charges you $100/month until you exceed your data threshold, which then begins charging you $15/gig of data. For this demonstration however we are going to ignore these expenses.
Contribution margin
The contribution margin formula is the formula used in the contribution approach for accounting. The formula for this approach is as follows:
Income
- Variable expenses
= Contribution Margin
- Fixed expenses
= Profit Margin
Your profit margin is how much savings you have per month after all expenses. This is derived from subtracting your fixed expenses from your contribution margin.
Utilizing the contribution margin concept to your benefit
The above concepts allow you to plan your expenses and reach your financial goals. Let’s say that someone has a monthly salary of $5,000, and every month has $2,000 in fixed expenses (rent, cable, etc.). With this, we know that they must have $2,000 in contribution margin to account for these fixed expenses, or $3,000 in variable expenses per month to break even and have zero savings. Knowing this, they can reach any financial goal under $3,000 in theory by decreasing their monthly variable expenses by a proportional amount.
This concept has allowed my girlfriend and I to increase our monthly savings by 100%. I set up a spreadsheet which calculates our allotted variable expenses per month based on our saving goals, income, and fixed expenses. We then keep track of our variable expenses and it illustrates our progress to our goal. I am planning on making a post in the near future with a youtube tutorial video and a link to this spreadsheet I created for anyone who is interested.
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I hope that you found this post interesting. If you have any questions, please comment below. My goal with this profile is to make frequent posts about finance, cryptocurrencies, investment, and wealth generation. I plan to not only make posts, but also youtube videos, and give away free excel workbooks to assist you in your personal finance goals. If this interests you, please let me know and follow my profile. Additionally, if you would like to reach out and ask any questions/request that I make a post on a topic, please reach out to me at [email protected].
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Great article
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