Achieving financial freedom is no small undertaking. It takes time, focus and discipline. In Part One of this two part series we discuss how to calculate your total annual expenses, as the first step to creating your plan for financial freedom.
This is Part One of a two part series discussing how to create your Freedom Plan. You can read Part Two here.
Setting The Scene
Before we delve into creating your personal Freedom Plan, I’d like to first offer you a couple of definitions which will come in useful:
I define financial freedom as having enough money to cover your expenses for life. The source of this money may be from savings, investments or passive income mechanisms. Once you are financially free you no longer need to work to earn money (though you can choose to continue to work if you want to).
I define income freedom as the ability to generate sufficient money from independent business ventures, that it covers your expenses so that you do not have to work for anyone else.
For example, someone who has built up enough regular income from their side hustles so that the money is sufficient to cover all their outgoings, would no longer need to work a regular day job. The side hustles become their new job!
The Path To Financial Freedom
In the pursuit of financial freedom it’s a good idea to pursue income freedom first. This is because it can take a very long time to amass enough investments to become truly financially independent. The length of time it takes to be able to quit your job can be considerably less if you take a two sided approach:
- Saving/Investing for financial freedom AND
- Creating money making side hustles for income freedom
We will discuss these two methods in more detail in Part Two. For now, we will begin the process of creating a freedom plan by working out your expenses. This is an essential first step, because to become financially free you must first know how much income you need each year, and you work this out by understanding what your total outgoings are.
I have outlined below the steps I recommend for calculating your expenses.
Calculating Your Expenses
Since there’s going to be some sums involved in this section, you may want to create a spreadsheet to log your expenses in. Alternatively, I have already created a template spreadsheet for my #lifedesigner subscribers. If you would like me to send you a copy of the template you can join my mailing list where you will be subscribed to receive updates from me about blog posts, side hustles and any fantastic offers I receive that I can pass onto you.
Right, let’s get started then…
1. List your automated regular monthly expenses
Make a list of all your monthly payments that automatically leave your bank account(s). You should be able to easily see these by looking at last month’s bank statement. Alternatively if you use online or telephone banking you can check under direct debit and standing order sections for your monthly payments.
We’re only looking for monthly amounts here, so ignore any annual direct debits or standing orders for now.
Once you have this list, add all the expenses together to get the total of your AUTOMATED MONTHLY EXPENSES.
2. List your other regular monthly expenses
Here we want to work out approximately what else you tend to spend money on every month.
This is quite a large category so it may take you a bit longer to work this one out. The kind of things I include in this section are:
- Groceries/Pet food
- Eating out/Take-aways
- Cinema/Theatre/Going Out
- Petrol/Car wash
- Health, Wellness & Beauty (eg haircuts, manicures, medicines, treatments like massages & chiropractor)
- Clothes/Shoes/Accessory purchases
- General spending money/Cash used
These amounts will vary from month to month, but you should be able to work out an average per category. If you’ve got time you could work out your average for the last year, but if not just use about 3 months. If you’re worried any of your averages are too low, just add a bit of contingency on.
Once you have this list, add all the expenses together to get the total of your REGULAR MONTHLY EXPENSES.
3. List your ad hoc or annual expenses
Here we need to consider any one-off, annual or infrequent expenses. Look back through your bank statements and bills over the past year to make a list of these expenses.
I’ve listed some examples below that fall into this category for me, though of course everyone is different. Some people may pay these monthly, others may not have these types of expenses at all. So please treat this as a guide:
- Car costs: tax, insurance, MOT, service, roadside recovery
- House costs: insurance (buildings and contents), maintenance, improvements
- Holiday costs: travel, accommodation, spending money, travel insurane
- Gift costs: birthdays, Christmas, anniversary, wedding, any other celebrations
- Memberships: gym, Costco, clubs
Don’t forget to add here any of your annual direct debit or standing orders.
Once you have this list, add all the expenses together to get the total of your AD HOC/ANNUAL EXPENSES.
4. See what your total annual expenses are
Now that we know all of your anticipated expenses across a year, we want to know the total that this all adds up to.
Calculate your total annual expenses using the following formula:
(AUTOMATED MONTHLY EXPENSES + REGULAR MONTHLY EXPENSES) x 12 + AD HOC/ANNUAL EXPENSES
Here’s an example. Let’s say you have the following figures for your expenses:
|Expense Type||Expense Amount|
|AUTOMATED MONTHLY EXPENSES||£1,000|
|REGULAR MONTHLY EXPENSES||£600|
|AD HOC/ANNUAL EXPENSES||£3,000|
Then your total annual expenses would be:
(£1,000 + £600) x 12 + £3,000 = £22,200
The amount you have here is your TOTAL ANNUAL EXPENSES.
5. See how much you need to make each month to cover your annual expenses
The final step for expenses is to understand the amount of money you need to be making each month in order to cover your annual expenses.
Divide your TOTAL ANNUAL EXPENSES number by 12 to get this figure.
Using the above example this would be:
£22,200 / 12 = £1,850 per month
The amount you have here is your TOTAL MONTHLY EXPENSES.
You’re Halfway To Creating Your Freedom Plan!
That’s all there is to it for calculating your expenses. In Part Two we’ll use the figures you’ve just calculated to create a plan for how you intend to cover your expenses, to ultimately become financially free. We will further discuss the two terms mentioned at the start of this post Financial Freedom and Income Freedom, covering aspects such as investing and generating income from side hustles. By the end of Part Two you’ll have your Freedom Plan! Check back next week for the second installment or join my mailing list to be notified of new posts as they are published.
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If you had a go at calculating your expenses, were you surprised with the total result? Did you find my instructions easy to follow? Have I forgotten anything? As always, I’d love to hear from you with your thoughts in the comments below…