Can You Afford That?

For people who are just entering the work force or who are relatively new to it, determining how much income it takes to live comfortably can be a challenge. Let’s assume you want to live at or above the level at which your parents live. How much money do you need to make? You might be surprised.

On the whole, you probably need to make more money than you expect in order to duplicate the life that your parents have. Quite frankly, ordinary living is expensive. Who hasn’t gotten a paycheck, only to be shocked at how little you take home and how quickly it disappears?

The main reason is simple: most things cost more than they seem to cost – for you, for your employer, and for the businesses producing the items you consume. We’re going to take a look at how much things really cost and some of the ways in which those costs are determined. To start thinking about how these factors add up, think about not just how much you pay for an item, but all that is built into earning, producing and selling it. And don’t forget to think about the taxes, for both the business selling the item, and for you, the employee. Taxes can add up, changing the bottom line on both what you pay for something and how much you have to spend.

Consider a Cup of Coffee

Coffee shops seem like a relatively inexpensive business to start, and most consumers can afford a visit to one. But think about it – how many cups of coffee would you have to sell to pay the rent? Pay employees? Pay yourself – if you even can afford to do so? You start getting the idea of what business owners must consider.
Writing for AZ Central, Steve Lander of Demand Media explores the cost of a single cup of coffee to a business owner. In “What Is the Profit Margin on a Cup of Coffee,” he details some of the ways in which the numbers add up.

For starters, he notes that business owners need to think about all the expenses that will affect their profits – directly and indirectly. A single cup of coffee involves water and beans, sure, but it also requires a container, with a lid and a thermal wrap if it’s a to-go. Many customers like to add milk or cream (don’t forget the alternatives such as soy), and sweetener, and they’ll need a stir stick and a napkin. Someone has to make that coffee, and a cashier needs to ring it up: those are labor costs.

Lander notes that, in 2011, the Specialty Coffee Association of American surveyed the cost of the components of a 16-ounce cup of coffee [1] – Grande for you Starbucks’ Fans. The coffee beans accounted for the majority of the cost: 64 cents (take a moment to ponder how those beans get to the coffee shop—they have to farmed, prepared and shipped, all of which cost money). Other items include the cup at 13 cents, the lid at 3 cents, sugar at 4 cents and labor worth 33 cents. Total cost: $1.17. Each of these costs can vary, depending on the quantity and quality of items used. But wait: where’s the profit?

That equates to 82 cents of gross profit on a cup of coffee; gross profit is the difference between revenue from sales and the cost of goods sold. When totaling net profits, however, one must consider a few more expenses. Lander’s article examines the fixed costs that coffee shops pay. Fixed costs are the expenses that do not change no matter how many goods or services are sold—these include rent and Internet service, which stay the same whether the coffee shop is packed or empty.

“Rent and utilities add about 15 cents to the price of the coffee, while marketing and advertising add five cents. Research to find the next great coffee drink costs 3 cents, while general administration of the store is 22 cents. Finally, taxes, interest and other miscellaneous costs add up 13 cents, making the fixed cost of a cup of coffee an additional 58 cents,” the article notes. [2]

All the figures add up to a total cost of $1.75 per cup of coffee, which creates a profit margin of 24 cents on a $1.99 cup of coffee. That 24 cents equates to the net profit, which is what the business owner really earns on a sale. In the case of an average cup of coffee, the net profit is about 1/8 of the cost.

Remember the Tax Factor

Let’s return to considering taxes for a moment. How taxes impact the bottom line remains one of the most important points to understand. Taxes affect every aspect of a business: choosing location, setting prices, hiring staff, and predicting break-even. Tax rates for unemployment insurance, workers’ compensation and payroll influence a business’ decision to hire another employee. [3] A report from MIT notes that tax rates mean that an employee who earns a $50,000 salary can actually cost from to $62,500 to $70,000 to the business. [4] The difference in those figures could be the difference between a business owner hiring an employee or doing the job herself.

As an employee, you’re affected by taxes in significant ways, too. Gross income is your total income before any deductions or federal, state or local taxes are withheld. It’s the salary level you usually talk about in a job interview, which in turn leads you to believe your paychecks will be higher than they are. Let’s say you’re offered a salary of $60,000 annually. That breaks down to $5,000 monthly. In reality, your take-home pay, or net income, will be considerably less, closer to $3,500 – it varies as you will see.

Expect your net income to be 60 to 70 percent of your gross income. [5] That means for every $1000 you negotiate in the interview, your paycheck will reflect $600 – $700.

The difference is due to exemptions you choose, taxes, and deductions such as health benefits and retirement savings. You must know and understand what your net income will be before you commit to new car payments, or even before you splurge every day on a cup of coffee. You also need to think about realistic salary levels. In an article based on his book, “The Graduate’s Guide to Life and Money,” Bill Pratt notes “the average college graduate overestimates their starting salary by 44 percent. It takes a lot of work just to remain in the middle class.”[6]

Understand Your Own Paycheck

Let’s return to the example of the coffee shop and the $1.99 cup of coffee, which you buy five days a week. Multiply $1.99 by 5, for a total of $9.95 per week or $39.80 per month. Multiply $9.95 per week by 52 working weeks per year, totaling $517.40 – not including tips or cost of gas to drive to the coffee shop.

Since we know that the $517.40 is your net income, let’s add back 30 percent to approximate your gross income on that amount, which brings the annual total cost of your cups of coffee to $739.14. In other words, you have to earn almost $740 in order to spend $520 on your daily coffee if 30% is withheld off the top of your paycheck. If you’re in a city such as New York, it’s closer to 40% rate and our coffee is usually more expensive! Take home pay to keep that coffee habit ($2.29 for same $1.99 cup everywhere else, 40% rate…) $992.

If your gross salary is $60,000, which is realistic for competitive early-career earners, daily coffee runs are precisely the kind of expense that you may need to monitor. Here’s an examination of what a $60,000 salary, or $5,000 a month, looks like.

These estimates are for a single person with no children and no special circumstances living in New York City. Exemptions and standard deductions each month average $858.33.

What are exemptions? They’re amounts of money that you can subtract from your adjusted gross income to reduce the amount of your taxable income. You complete a W-4 form from your employer to indicate how many exemptions you’ll take. For each exemption, the government “exempts” a portion of your paycheck from being taxed. The more exemptions you take, the less comes out of your paycheck. [7]

Keep in mind, notes Pratt, that at the end of the year, your tax liability is calculated based on your income for the year. “So, if you took too many exemptions and did not have enough taxes taken out of each paycheck, you will owe the difference,” he writes. [8] Pay now or pay in April….

Exemptions are essentially the same as a deduction, which is also a tax-free amount that comes out of your paycheck and reduces your tax liability. [9] The $858.33 we’ve used is based on a single individual exemption plus a standard deduction.

After exemptions, your taxable monthly income is now $4141.67.

Subtract the following: Federal income tax, $683.02; New York state income tax, $253.98; Social Security, $310.00; Medicare, $72.50; [10] and New York City tax, $141.16. [11][12] Your take home pay each month now equals $2681.01 plus the $858.33 that was exempt for a total of $3,539.34. Since 69% of 20-somethings have college debt averaging $28,950, we’ll use $183.39 as the approximate monthly student loan debt.[13] Now you have $3,355.95 to live it up. Right?

That’s the amount you have left to pay all your expenses, which might play out each month as follows:
Rent, for a single person living alone in a 480-square foot studio apartment: $1904.00; utilities for that studio, $100.00; Internet, $57.00; cell phone, $75.00; Metro fare, $120.00; food, $450.00. [14] These expenses, which are reliable estimates, total $2706.00 per month; not included are expenses for laundry, clothing, student loans, entertainment and so on. Remember your, take-home pay is $3,355.95. So your net take-home pay after making sure you keep your lights on at home is $649.95. That’s approximately 1/8th of the base salary of $5,000/mo. Particularly when in NYC, living in shoeboxes makes sense. But that’s not even the worst of it.

An employee being paid $60,000 annually costs a company about 1.25 times that salary, or $75,000. The additional costs come from employee benefits, such as health insurance and the cost of Medicare and Social Security to the business, along with fixed costs such as renting space. The business must bring in 1.25 times the salary of every employee in the company just to cover the cost of the salary. Entrepreneur Ryan Born explains that, because most companies have a gross profit (profit before taxes, overhead, administration, etc.) of about 50% to stay in business, the company must generate $150,000 for every employee who makes $60,000 a year—including you. [15]

That puts pressure on you to generate $150,000 of revenue to pay for yourself at breakeven.

Let’s take one last look at that $1.99 cup of coffee. It costs you $39.80 per month and your take home pay is $3,539,34 per month. The coffee equates to about 1.1 percent of your monthly take home pay. It could hold its own as a budget ledger line. Surprised?

Extrapolate these costs to every item you buy. You’ll start to get a clear picture of why your paychecks seem to disappear extraordinarily quickly and why it might feel as though you may never live as well as your parents – certainly you won’t reach their standard of living as easily as they seemed to reach it. That sense—a valid one—is not due to tax rates alone. It enfolds a number of other factors, such as slower job growth and increased student loan debts for younger earners. None of these circumstances is likely to change soon. Your best tool for reaching specific financial goals is to understand how much money you need to earn, and how much you need to save. Knowledge, in this case, does have the power to give you a solid financial hand in the future.

[1] Lander, Steve. “What is the Profit Margin on a Cup of Coffee,” 20 June 2016.
[2] Lander.
[3] Lister, Jonathan. “How Taxes Affect Businesses,” 20 June 2016.
[4] “How Much Does an Employee Cost,” 20 June 2016.
[5] Pratt, Bill. “Understanding Your Paycheck,”, 20 June 2016.
[6] Pratt.
[7] Pratt, Bill. “Taxes, Exemptions and Stretching Your Paycheck,”, 25 June 2016.
[8] Pratt (ibid.).
[9] 25 June 2016.
[11] 23 June 2016.
[12] 23 June 2016.
[14] 23 June 2016.
[15] Born, Ryan. “Back of the Envelope: How to Estimate the Annual Revenues of Any Private Company,”, 22 June 2016.