Some basics – knowing the difference between expenses and liabilities. Liabilities are created because of the way that you chose to pay for something. When you purchase a car by taking out a loan, you are buying an asset (the car) and creating a liability (the loan). When you buy something on a credit card, you are creating a liability. A liability is something that you need to pay – even if you get nothing of any value in the future. You already committed future income to pay for something that you got in the past – a car, an education, a dinner out, etc. Often with liabilities you will pay more for something because you are paying interest.
Good versus bad liabilities? Am I improving my situation for as long as or longer than the liability will last? By taking out a car loan, I can get to work and improve my financial future. By taking out a mortgage, I can purchase a home and it gives me a place to live. By borrowing funds to purchase a new refrigerator I can have groceries in the home and do not have to eat out all the time. These can be good reasons for taking out debt since I am getting a benefit that should last longer than the payments.
Taking out a loan for a vacation – once the vacation is over and I am still paying the loan a year later, how am I improving my life when I make the 10th or 15th loan payment? Charging items on a credit card that I continually carry a balance on means that I am paying for a meal out that I had 2 months or even 2 years ago.
Expenses are payments that I am making for things that do not last or have little future value. For example, paying the electric or water bill for what I used last month does not have any future value for me. Once the period has passed that I paid insurance for, there is no value left.
As you work to create your spending plan, expenses and liabilities will be tracked separately. Begin thinking of how much of your income is currently being spent on expenses and how much is needed to pay liabilities.