muhuk's blog

Nature, to Be Commanded, Must Be Obeyed

April 11, 2013

Personal Finance for Geeks

I never bothered to do my accounting until two years ago. I was talking to a friend and I learned he was keeping a record of his earnings and spendings, mostly just to toy with this open source software called Ledger.

There wasn’t much point in keeping a personal record of my finances since there wasn’t much money. But being an abundantly curious person, that didn’t stop me. All the while I was thinking that I was learning this Ledger software, but in reality I had been learning the basics of personal finance.

I had been following The Simple Dollar for some time. But before I started collecting data using Ledger, I had actually never taken action on a personal finance advice. I have been keeping a ledger since then I can say it really helped me understand the key concepts of equity, assets. liabilities and expenses. The point, for me at least, is not to become a Donald Trump. But find comfort in the fact that I won’t wake up and find myself in a financial crisis.

Ledger is really simple. I am guessing the readers of my blog will appreciate the fact that the data is kept in plain text files. Entries look something like this:

03/29 ACME Movie Corp
    Expenses:Dining                         S$15.50
    Expenses:Entertainment                  S$24.00
    Assets:Cash

This is called double-entry accounting. Each entry is balanced within itself. In this fictitious example money comes out from Assets:Cash account and goes into Expenses:Dining and Expenses:Entertainment. Suppose you went to the movies with your girlfriend and also bought soda and popcorn before the screening, and paid both in cash.

Budgeting Is Overrated

You don’t really need a budget. If you want to have a budget, Ledger has this functionality. I have played with budgeting a little bit. Although it gives you a sense of accomplishment, for me it doesn’t have a lot of practical use. I want to see where my money goes and I want to avoid being broke at the end of the month. As long as I meet these two modest goals, I want to be able to spend my money on whatever I want.

But that doesn’t mean I go out and spend all my earnings on stupid things. And that doesn’t mean I spend every penny I earn. I have adopted simpler and less rigid techniques than keeping a budget. I might blog about them in the future. Right now, the point I am trying to make is personal accounting doesn’t require keeping a budget for you to benefit from it.

How You Structure Your Ledger Is Up to You

Ledger doesn’t provide you a default structure. You start with an empty text file which means you start with an empty ledger. How you define your accounts and how you record your transactions determines what kind of a ledger you are keeping.

For instance you can go crazy and assign a value to your time. Then you can record the times you do work as billable hours and also you can go ahead and record the hours you spend on chores and entertainment. So you can put a monetary value on the time you spend on yourself and the time you spend to earn money. Of course the unit value of your time can change in time and Ledger handles that nicely.

I would suggest starting with a very simple model that would be able to answer simple questions like:

  • How much money in total do I have right now?
  • How much did I spend last week/month/year?

For this, I suggest using the following accounting equation

Equity + Income + Liabilities = Assets + Expenses

I will not try to explain how this equation work exactly. Just know that the sum of the left hand side and the sum of the right hand side balances each other out. Otherwise you have made a mistake. I will however try to define each variable as best as I can.

Equity is what you have acquired by right. An example to equity is when you rollover your ledger at the end of the year you credit your assets from your equity account. Because they have been aquired, they were assets in the last year’s ledger. They are still there, your cash is still in your pocket. When you start this year’s ledger you need to credit the same amounts to your assets. And this money needs to come from somewhere, and that somewhere is equity. For this reason equity account is typically negative. You keep drawing from it.

Income is similar to equity, in fact it can be merged with it. But it makes sense to record income seperately for analytical reasons as well as due to the difference that you exchange something in return of that income.

Liabilities are acquired with a promise to pay back. A simple example is when you borrow money from a friend. A more complex example is when you use your credit card to pay for something. First you credit your expenses from your liabilities. Then when you pay your credit card debt you credit your liabilities from your assets. Ideally your liabilities should be close to zero most of the time.

Assets are what you are holding onto. The money in your bank account and in your wallet are assets. Theoretically you can keep records of your non-monetary assets such as a house or a car. But it can get pretty complicated then, since you have to take devaluation, taxes etc. into account. I would say keep it simple and record only monetary values. If you have a stock portfolio you can keep a record of it’s aggregated profits and losses whenever you balance your ledger. Trying to keep an account for each individual stock and updating it every day is probably overkill for beginners.

Expenses are what you have exchanged for something else. Hopefully for something that is of greater or equal value. Your expenses account is always credited[1]. Having sub accounts helps understand where the money goes. This is probably the most important subject personal finance gurus are ranting about; how to strategize different types of expenses. I would just like to make a simple distinction between needs and wants. But in my ledger I actually have many sub accounts under expenses, such as Expenses:Rent, Expenses:Entertainment and Expenses:Dining.

Ledger is Free Software

Even if you are not into accounting, Ledger is worth experimenting with just for its life hacking value. Once you start paying attention you might get new insights. After all what gets measured, gets managed.

[1]The only exception is when you return something and get a refund.

If you have any questions, suggestions or corrections feel free to drop me a line.