Thursday, 13 August 2009

Money money money

Mr Macawber in David Copperfield by Charles Dickens, explains the concept of budgeting thus. “Annual income twenty pounds, annual expenditure nineteen pounds six, result happiness. Annual income twenty pounds, annual expenditure twenty pound nought and six, result misery.”

There has been a lot of talk and discussion about the current financial situation the UK finds itself in and for the average man in the street the discussions about millions and billions are meaningless unless they can relate the issues to their daily lives. This blog therefore is my attempt to portray the current situation as if the same issue affected an average family. At least it's my attempt to explain it as far as I understand it; please keep in mind I'm no Vince Cable.

Take the example of someone in a relatively stable job working 9 to 5. During times when business is good the management suggest that they start work at 8.30 and finish at 5.30 earning themselves some overtime and additional income. Over time they become used to having the extra money and it has worked its way into their normal budget. At the end of the week when the bills for electricity, heat, petrol, mortgage and car loan have been paid they have £100 left to spend on groceries which they happily do. They become used to a standard of living based on a certain income.

Then things change, the business isn't as profitable and management don't need that extra hour from the staff so overtime is cut. When the end of the week comes and the bills are paid there is only £75 left for groceries. Being used to a certain standard of living the individual still collects the same shopping as usual. They pay their £75 in cash and put the remaining £25 on their credit card in the sure and certain expectation that things will improve. This continues for a few weeks and becomes routine, since the same standard of living is maintained there is no need to look at alternatives, no need to change the way they shop, no need to look at the other bills to try and reduce them, no need to look for further income.

Then one day when the cash is paid and the credit card is handed over the cashier looks up expectantly and utters those dreaded words "I'm sorry but your card has been declined". The immediate consequence is to identify those elements of the weekly shop that you can do without in the short term but the longer term consequence is going to be more difficult. In future you won't have £75 to spend on groceries because you must add £10 to the existing bills to pay off the credit card loan. Thats fine if you can easily get by on £65 of groceries but what if the absolute minimum you need is £70 or £75. As Mr Macawber would point out: result misery. There were a number of choices which could have been made when the problem first arose, did the individual really need Sky Sports?, did they really need the car?, could they have taken a part-time job to make up their income?. At first deciding on any one of these may have addressed the short fall or alternatively a review of the weekly shop to look for better value may have meant a balanced budget. Now however as things have deteriorated the ability to choose a course of action is limited and the possibility exists that all options will have to be implemented.

Of course with hindsight there are lessons to be learnt. Don't expect that the maximum level of income available will be the norm. What would have been the outcome had the budget for groceries been set at £75 with any additional income set aside as savings? The focus on value for money may very well have been more pronounced and that £25 would have established a useful fund to be used for major items or a rainy day. Enough savings would have paid for the car rather than taking a further loan and paying the interest on the loan. The money left when the bills were paid would have been increased by the level of the car loan repayment.

And for Governments who wield the credit cards in the face of reduced income there are similar lessons, acting quickly gives you choices, delay and you will have others make choices for you. Credit is a useful business tool but there must be limits. Some things will have to wait until resources are available and some things we are paying for we do not need.