Budget questions. (wordy)

[Chris Shoemaker]

On Wed, Nov 09, 2005 at 08:29:28AM -0500, Tim Wunder wrote:
> "cash budget" vs "expense budget"? You keep using the term "cash budget" as if 
> I should know what you're talking about, but, well, I dont :(

A cash budget is probably what you think of when you think "budget".
Google can provide formal definitions if you like, but your intuition
is probably good enough.  Note: I didn't use the term "expense budget".
Thomas did, and I don't know exactly what that means, but he's right
that there's more than one type.  There are several types - all
similar but different.  (Like a claw hammer, sledge hammer, finishing
hammer, mallet, etc.)

> > Let's say you "buy" a car with a CC and you want to budget paying it
> > off.  (1) You could create a Car expense account and as you pay off
> > the CC, you increase the Car expense account.  It's like you're buying
> > it a little bit at a time.  or (2) You could pay the CC with an
> > asset->liability transfer, with *no record* of what the actual expense
> > was, and then use the CC liability account in the cash budget.
> >
> 
> OK, in my case, the record of the expense was created when the liability was 
> incurred. Say I used a CC to buy a fridge using a 0% interest CC card. Now I 
> want to budget paying down the liability. That would seem to be choice (2), 
> if I'm following along. The same can be applied to a loan. I create a loan 
> liability account to pay for a new car. The creation of the balance on the 
> liability account is causes a balancing entry to the asset account for the 
> new car.

This is a good example, because it shows two different ways of doing
the same thing.  I'll call them the "expense" method and the "asset"
method, since they both revolve around a liability.  You used the
expense method for the fridge:

"bought a fridge"
Expense:Household               $600
Liability:CC             $600

[both accounts increase]  Later, 

"CC payment"
Assets:Checking     $200
Liability::CC               $200

"CC payment"
Assets:Checking     $200
Liability::CC               $200

"CC payment"
Assets:Checking     $200
Liability::CC               $200
[both accounts decrease]

For budgeting purposes, you may only want to budget for the cost of
the fridge *once*.  You can describe your plan in one of two ways: "I
plan to spend $600 on Household expenses this month. (ignoring the CC
payment)" OR "I plan to have 3 $200 CC bills these months.  (ignoring
what you bought.)

The first budget looks like:

Budget A:
                Jan     Feb     Mar     Apr
Ex:Household    600     0       0       0

The second budget looks like:

Budget B:
                Jan     Feb     Mar     Apr
Asset:Checking    +0    -200    -200    -200    
Lia:CC          +600    -200    -200    -200

[I wrote +/- to emphasize that this is only the *difference* in month
to month account values, it has nothing to do with the account
balance. ]

Both budgets describe the same plan with different details - The first
emphasizes *what* you (plan to) spend your money on; the second
emphasizes *when* you (plan to) spend your money.  You may only care
about one or the other, and are free to choose appropriately.  Of
course, if you care about both you have to plan for both:

Budget C:
                Jan     Feb     Mar     Apr
Asset:Checking   +0    -200    -200    -200    
Lia:CC          600    -200    -200    -200
Ex:Household    600       0       0       0

Now let's look at the "asset" method, and add an extra zero for the
car.  You may choose to record your new liability with an offseting
asset instead of an expense:

"Bought a new car"
Asset:NewCar            $6000
Liabilty:CC    $6000

[both accounts increase] Later,

"Car payment"
Asset:Checking   $2000
Liability:CC            $2000

"Car payment"
Asset:Checking   $2000
Liability:CC            $2000

"Car payment"
Asset:Checking   $2000
Liability:CC            $2000
[both accounts decrease]

Again, how you budget for these transactions depends on whether you
care more about *what* you spend money on or *when* you spend your
money.

Budget D  "the what":
                Jan     Feb       Mar     Apr
Asset:NewCar    +6000     0         0       0

Budget E  "the when":
                Jan      Feb       Mar     Apr
Asset:Checking      0  -2000     -2000   -2000
Lia:CC          +6000  -2000     -2000   -2000

Budget F  "the what and when":
                Jan      Feb       Mar     Apr
Asset:NewCar    +6000      0         0       0
Asset:Checking      0  -2000     -2000   -2000
Lia:CC          +6000  -2000     -2000   -2000


Notice that Budgets B and E are essentially the same.  They're both
essentially differential views of a cash-flow projection.  (There's
nothing wrong with that, but many people find it easier to interpret a
cash-flow projection by looking at the actual account balances over
time, since you're really trying to answer the question "Are we going
to have enough money at the right times?"  which you can answer pretty
easily by looking for an account balance to go negative.)

Also notice that Budgets A and D, are similar, but reflect the
different choices of using an expense account or an asset account.

That begs the question: "When should I use the asset method and when
should I use the expense method?"  If you use the asset method, and
you want your asset accounts to accurately reflect your real assets
you *have* to make depreciation entries to account for depreciation.
There's no such requirement for expense accounts.  So, my
unprofessional recommendation would be to only use the asset method if:

A) You must have an accurate asset picture, say for reporting purposes
or for precise net-worth estimates; OR 

B) You plan on deducting depreciation from your income for tax
purposes - something that businesses commonly do, and individuals
commonly don't; OR

C) You find it easier than the expense method and don't care if you
have unrealistically inflated asset accounts over time.

Otherwise, I'd stick with the expense method - fewer things to record,
since you're not tracking incremental depreciation of an asset.
 
> OK, I still need a rudimentary tutorial on what other kind of budget, rather 
> than a cash budget, could be utilized to track, for lack of a better way to 
> put it, where the user plans for the money to go month to month. Is the 
> budget intended to ship (if all goes well) in G2 a cash budget?

Yes, and that's what a cash budget tracks.  That's how I use it, and I
think it will work for you, too.

> > Let's say you "buy" a car with a CC and you want to budget paying it
> > off.  (1) You could create a Car expense account and as you pay off
> > the CC, you increase the Car expense account.  It's like you're buying
> > it a little bit at a time.  or (2) You could pay the CC with an
> > asset->liability transfer, with *no record* of what the actual expense
> > was, and then use the CC liability account in the cash budget.
> >
> > In any situation where your records actually *have* to record what you
> > spend money on, (1) is mandatory.(*)  What I wonder is whether allowing
> > (2) is worth the (possible) confusion.
> >
> 
> But (2) does *not* preclude the existence of (1). By doing an Asset->Liability 
> transfer (2) I can still find out what the expense was (or asset purchase, in 
> the case of buying a fridge), even though at the time of the (2) transaction, 
> record of the expense is not made. The record of the expense (1) was made 
> when the liability was incurred.

You're right.  I shouldn't have said "no record", but notice an
important difference: Where is the information about *what* the money
was spent for?  In (1), it's in each of the expense transactions in
the various expense accounts.  In (2), it's in the text field of the
transaction that paid off the debt.  What description to use if you
don't pay off the whole fridge?  Or if you CC bill includes the fridge
plus entertainment plus medical, etc.?  Sure, you can do it with
splits, but it's awkward.  And what report can you run when you want
to know how much you spent on medical?

Liability accounts are usually organized around *whom* you owe, not
*what* you bought - that's what expense accounts are for.  Looking in
liability accounts for information about how you spent your money may
happen to work if there's a one-to-one relation between what you
borrow money for and whom you borrow it from.  I'm not going to say
that's TheWrongWay, but I'm not going to recommend it either.  Someone
who _needs_ to do it that way already knows _why_ they need to do it that
way.

> Hmmm... don't wanna *be* a real accountant, I just wanna plan where my money 
> is going to go over the next 12 months ;)

Same here, buddy.  :)  I'm interested in hearing how you fare.

-chris