Understanding your cash flow simply means knowing exactly what your income is and what your expenses are month by month over a given period. You need this information before you can make even the most basic financial decisions.
If, for example, you are wondering whether or not to buy an investment asset or whether to borrow money, these seven steps will provide you with your answer. They can be seen as a kind of financial litmus test, because they will reveal the effect that purchase decisions will have on your cash fl ow. Since your cash fl ow has a major impact on how you live your life, you are then in a position to decide if the sacrifice is worth the potential benefit. This is the risk–reward decision-making process — ‘short-term pain for long-term gain’.
Step 1: calculate your income
Each taxpayer has to lodge an individual tax return, so be sure to include only your own income and expenses. For example, if an asset, such as a property, is proportionately owned — you own 50 per cent and your partner owns 50 per cent — then list only the proportion of the income (or expense) that applies to you. In this case, you would include 50 per cent of the income from the property among your total income (and include 50 per cent of the expenses among your expenses).
Step 2: calculate your tax-deductible expenses
Tax-deductible expenses are the expenses you incur in generating your income or in undertaking education relating to your work.
TIP! Check the ATO website for info on deductions
See the Australian Tax Office website for more information on allowable deductions www.ato.gov.au
Some examples of tax-deductible expenses are work uniforms, education relevant to your work, motorvehicle use to visit clients, and investment expenses such as interest on investment loans.
Step 3: calculate your taxable income
Your taxable income (C) is your total income (A) minus any allowable deductions (B). Simply subtract your deductions from your total income.
Partner 1
(A) $____________ – (B) $_____________ = (C) $_____________
Partner 2 (if appropriate)
(A) $____________ – (B) $_____________ = (C) $_____________
Step 4: calculate your tax
Tax is calculated on a sliding scale: the more you earn, the higher proportion of tax you will pay. If you earn $50,000 per annum, the first $6000 is tax free, the next $31 000 (up to $37 000) will be taxed at 15 per cent, and from $37 001 to $50 000, you will be taxed at 30 per cent.
Eg. Your tax on $50 000 would be $8550*
($4650 + ($50 000 – $37 000 × 30% = $3900) = $8550).
Eg. 2 If you earn $80 000 per annum, you would pay $17 550 in tax ($4650 + $12 900.)
Tax ratesacket % rate of tax* $ amount of tax
$0–6 000 0 $0
$6 001–37 000 15 $4 650
$37 001–80 000 30 $12 900
$80 001–180 000 37 $37 000
$180 001+ 45 (not applicable)
* Tax rates applicable for the 2010–2011 tax year, excluding Medicare levy of 1.5%.
TIP! Online tax calculators
Alternatively, there is a simple tax calculator on the Henderson Maxwell website www.hendersonmaxwell.com.au in the resources section. This can be saved in Excel format for you to keep on your own computer, and the tax brackets can be changed as legislation changes.
For an official ATO tax calculator, see the ATO website http://calculators.ato.gov.au/scripts/asp/simpletaxcalc/main.asp
Step 5: calculate your after-tax income
Your after-tax income (E) is simply your taxable income (C) minus the amount of tax you have to pay (D).
Partner 1
(C) $____________ – (D) $_____________= (E) $_____________
Partner 2
(C) $____________ – (D) $_____________= (E) $_____________
Step 6: calculate your non-deductible expenses
Your non-deductible expenses (F) are all your living expenses apart from those for which you can claim a tax deduction. For most people, they include things like food, rent, mortgage payments, council rates, entertainment, utilities (such as gas, electricity and telephone), and house and car insurance. A good guide to these expenses will be the past 12 months’ bank statements, credit card statements, receipts or any other source documents you have.
Step 7: calculate your net income (also known as your surplus or deficit income)
Your net income (G) is your after-tax income (E) minus your non-deductible expenses (F). In other words, your net income is your surplus income, the money that you have available for saving or investing.
Partner 1
(E) $__________ – (F) $ ______________ = (G) $ ___________
Partner 2
(E) $__________ – (F) $ ______________ = (G) $ ___________
The importance of the seven-step process
Again, I’d like to stress the importance of undertaking this seven-step process each time you consider buying an investment asset or any major item. This is crucial, because the tax effect can be a real kicker when you find that the Australian government is contributing to your purchase via tax credits. Tax deductions are like having the government pay a large portion of your tax-deductible expenses, because those expenses are deducted from your gross income before you pay tax.
The budget planner on the Circle website will assist you to accurately record all of your income and expenses on a monthly basis.
Now that you have undertaken the seven-step process and understand your own cash fl ow, it stands to reason that you should monitor and review your cash flow as time progresses. Your cash flow will change for varying reasons, including job or career changes, having a child or more children, economic conditions and other challenges that may arise from time to time. While you should monitor your cash flow regularly, say every six months, it also needs to be updated each time something changes significantly. Changes will occur for better and
for worse and so, too, your income will rise and fall throughout your life. If you have a solid grasp of your financial position, you can make informed decisions in a timely fashion.
Key points
• Don’t rely on the government for financial assistance.
• Motivation, application and structure will see you through the financial planning process.
• Identify your goals and objectives and write them down.
• Establish a solid understanding of your cash flow, as that forms the basis of all your financial decision making, both now and in the future.
• Now you know and understand your budget, stick to it.
• Undertaking these activities places you firmly in the box seat for financial success. Well done!
Sam’s book ‘Financial Planning DIY Guide’ can be purchased at Sam’s website www.hendersonmaxwell.com.au for $34.95 (+PP) or from all good bookshops.
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