Image courtesy of patrisyu at FreeDigitalPhotos.net
When I think of and use the term “margin” I think of the additional beyond the minimum requirement.
In a business sense the margin is the difference between the income and the expenses. (*That difference isn’t always cash-in-hand “profit” by the way.) The margin is often reflected as a percentage and you can easily see from public records what the margin percentage is for publicly traded companies by looking at their quarterly financial reports.
*The reason margin, even “profit margin”, isn’t cash-in-hand money is generally due to things like taxes, capital investments that are depreciated versus expensed, and other reinvestments back into the business. In fact, a certain amount of margin is often necessary just to break even from a cashflow perspective.
In a personal sense margin is very similar. It’s the “extra” you have remaining from your income once your expenses are paid out. If you live paycheck-to-paycheck and have to defer certain expenses until the next check arrives, you likely have little or any margin. But if you stash money into savings or investments on a regular basis, then that represents a level of positive margin for you.
In either business or personal, margin is important. To summarize the main reason: because things happen. Business climates change. Competitors come and go. Costs of goods fluctuate. Economic conditions are variable. Cars break down. Babies are born. People get sick. Basically, things happen. It isn’t always clear what will happen or how large the impact will be, but you can bank on the fact that things will indeed happen at different points. And if you don’t have any margin, this can sink you.
Without a decent level of margin and increase in costs or decrease in revenues can literally sink a company. It can force layoffs and other cost-cutting measures and it can sometimes even drive the company out of business.
With a decent level of personal margin a shift in employment (decrease of revenues/income) or a major medical expense (jump in costs) can have a similarly disastrous impact. Two of the top five reasons that people wind up bankrupt are medical expenses and job loss.
Of course an emergency fund can help push through short term unexpected situations, but to build – and later replenish – the emergency fund takes, guess what, yes – margin.
If you run a successful business you are either very lucky or you already have a decent handle on margin. You know what impacts it and work to optimize it; you know what types of fluctuations in business conditions you can handle; and you likely even have a set of contingency plans in mind in case something goes wrong.
Many people don’t have this same level of fiscal knowledge and planning for their personal lives though – even ones who are very successful in their corporate lives. But everyone should understand this and have a plan in place.
It starts with understanding your income and expenses. I mean your cash income, not your salary. What do you actually put in the bank each month after taxes and anything else is withheld from your paycheck? And then your expenses – living expenses (mortgage, rent, HOA, insurance, utilities, etc.), average medical expenses, vacation budgets, college saving requirements, cable TV, etc. Use a program like Quicken or another that allows nice and easy reporting – then use it. It doesn’t help if you don’t record every single income and expense and also assign a category to each of these. Something like Quicken will also allow you to define budget categories, assign amounts, and report on whether you are over or under in various categories for a defined period of time.
You can also just use a spreadsheet. Look at your paycheck and the cash amount you get each month. Put it at the top of the spreadsheet. Now for one month every time you get a bill add a line to the spreadsheet and put in the amount. You might need to do this for a few months if you have some variable expenses (like things paid quarterly). But after a couple of months you should have a good grip on your expenses and will be able to easily total these in the spreadsheet.
Note the difference between that cash income and the average monthly expenses. That’s margin. Does it look like more than you expected? Is it a bigger amount that you really have left over each month? If so, you’ve likely left some things off. Do you perform regular car service every few months? Do you eat our or order take-out a couple times each month? Do you stop for a coffee some mornings? These little things really add up so you need to be gut-level honest when documenting all of your expenses.
You also need to look for items that might not have come up in a monthly audit. Do you spend a few thousand each year on vacations? If so, divide that amount by twelve and add it to the monthly budget. Do you tend to buy a new car every five years? Guess what, that adds up, figure out that monthly cost and put it on your budget. Car insurance paid every six months? Make sure that is there.
If you do the budget process properly, the amount “left over” (margin) should fairly accurately line up with what you see in your bank account. In fact, the cash amount in the bank should be higher because of the variable items mentioned in the previous paragraph. If you don’t have any margin – literally spending more than you make – or have very little margin, start looking for ways to change this. Either looks for ways to increase your income, or better yet, look for ways to decrease your expenses. (Why is an expense decrease better? Because the lower your cost of living, the more flexibility and options you have. The closer to get to retirement the ever more important this becomes.)
I’ve given some food for thought on margin and a good first step (budgeting) in understanding your margin. Take this information now and ponder your current situation. Also get a vision for how much margin you’d like to have and some steps on how to reach that goal. More margin equals less risk and less stress. More margin also means easier saving and investing, which you’ll really appreciate the closer you get to retirement.
Hope this helps!