Everyone knows how much they make, be it their annual salary gross or in net terms, but those numbers are generally too big to be meaningful for our everyday expenditures. It can be difficult to really understand the cost of a purchase, such as if we want to buy a new laptop or TV set. We think we earn a certain amount per year, and we can even calculate it down to the month, but what about by the hour? (Test your money management skills as you work your way through university. Check out Budgeting While You're in College.)
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It would be more concrete to measure the cost of products and rank the need in our lives by knowing how many hours of work it would take to buy it, rather than just looking at the cost of the item. Here are three wage calculations worth knowing when you consider making a purchase: gross wage per hour, net wage per hour and disposable wage per hour.
1. Gross Wage per Hour
Gross income is income earned before any deductions such as taxes are taken out, and determining that number is one of the simplest to calculate. Take your gross annual income and divide it by 2,000. Why 2,000? It is the generally accepted number of working hours in a year, and it is easy to divide into as well:
- 52 weeks in a year, less two weeks for vacation for a total of 50 weeks
- 50 weeks multiplied by 40 hours a week = 2,000 hours
Naturally, if you take three weeks of vacation, you might want to tweak your personal number to reflect that.
Let's say we're buying a $2,000 laptop (taxes included). If you earned $50,000 a year, the breakdown of how many hours it would take to buy that laptop would look like this:
- $50,000 gross annual income / 2,000 hours = $25/hour (gross wage earned)
- $2,000 laptop / $25/hour = 80 hours
You'd be working 80 hours or two weeks to pay for that laptop.
2. Net Wage per Hour
Net income is what you have earned after deductions. This is a calculation based on your take-home pay, and the only difference is that you'll use your income after taxes, instead of your gross income.
The same $50,000 gross income we discussed before means a $38,000 net income, using a 24% tax rate:
- $38,000 net annual income / 2,000 hours = $19/hour (net wage earned)
- $2,000 laptop / $19/hour = 105.26 hours
You'd be working 105 hours give or take a couple of minutes, or 2.6 weeks to pay for that laptop. (Can you have perfect abs in just six minutes a day? Maybe not, but you can have a rock-solid budget in six months. See 6 Months To A Better Budget.)
3. Disposable Wage per Hour
This final calculation is the most accurate because it uses your net income, but also accounts for how much you have to pay for your expenses such as shelter and food; what's left in the end is your disposable income, which is the money you can spend on anything you'd like.
This calculation requires you to use real or estimated budget numbers, and a hypothetical calculation might go something like this:
We already know that for a $50,000 gross income, $38,000 is your net income after taxes, which gives you $3,166.67 per month to spend.
So here's what your hypothetical budget might look like for the month:
- Rent = $1,500
- Utilities = $125
- Cell phone = $50
- Groceries = $250
- Car Payment = $200
- Gas = $100
- Car Insurance = $200
- Life Insurance = $50
- Apartment Insurance = $25
- Savings = $100
- Retirement = $200
Total = $2,800/month spent on living after taxes and other deductions
To find out your disposable income take your per-month net income ($3,166.67) less your living expenses and necessary deductions ($2,800). This leaves you with $366.67 in disposable income per month for entertainment. Multiply that $366.67 by 12 months, and you'll get $4,400.04 for the whole year.
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Divide that $4400.04 by 2,000 working hours and you will get $2.20 as your disposable wage per hour.
This is a far cry from your gross wage per hour ($25) and your net wage per hour ($19), but it's what is leftover in your budget after covering your essential expenses.
So how much would that laptop cost?
$2,000 laptop / $2.20 disposable wage per hour = 909.09 hours
You would have to work 909 hours or almost 23 weeks to pay for that laptop, given your disposable wage per hour.
The Bottom Line
A purchase that isn't an essential item is not just the cost, because knowing the basics of how to translate the true cost of something into a hard number of working hours is a great way to rank your purchases according to your priorities and needs.
You can always dip into your savings for some instant gratification, but instead of just looking at just the dollar cost of the item, consider the cost of how long you'd have to work for the item, and it may not be such a great purchase after all. (Cruise through a slowing economy - even when others are going off the rails. For more information, check out Five Strategies For Surviving Tough Times.)
For the latest financial news, see Water Cooler Finance: The Beginning Of A Foreclosure Crisis?
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