Budgeting really should be the foundation of personal finance. Whether or not you write down a personal budget, use a budget spreadsheet, use a budgeting app, or you simply keep track of your finances in your head — you’re probably already budgeting.
What is budgeting? Basically, it’s making sure that you’re spending less than you’re bringing in and planning for both the short (immediate future)- and long-term (decades to come).
And budgeting is never more important than in your early adult life as you figure out how to optimally utilize your periodic pay-cheque, pay off debt, and — hopefully — save a little bit, too.
What is a Budget, Exactly?
A monthly budget is a plan for how you will allocate income to meet your expenses for a designated month. Some think of budgets as spending constraints (placing unnecessary restrictions on spending), but budgets are better described as “spending plans”. If you budget correctly you will be able to spend money on things you enjoy without worrying about meeting other financial obligations, overdrawing your accounts, or going into debt. A budget can be made for a person, a family, an event, a group of people, a business, a government, a country, a multinational organization or just about anything else that makes and spends money. A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged for another.
A budget is an estimation of the revenue and expenses over a specified future period of time and is compiled and re-evaluated on a periodic basis. A monthly budget typically consists of a list describing your income sources and expenses. Each description is followed by the amount you project for the amount of the income or expense for the designated month.
A surplus budget means you have enough to put aside, for savings maybe, while a balanced budget means that revenues are expected to equal expenses. A deficit budget means expenses will exceed revenues.
A monthly budget can be an Excel spreadsheet, or simply jotted on a piece of notebook paper.
Budget Development Process
The budget process begins by establishing assumptions for the upcoming budget period. These assumptions are related to projected sales trends, cost trends, income trends and overall economic outlook of the market. Specific factors affecting potential expenses must also be addressed and monitored. The procedures include the assumptions of the markets, key relationships with vendors that provide discounts and how certain calculations were made.
Writing Your Budget
A monthly budget is an estimate, but your goal should be to make as educated an estimate as possible. To do this, you will want to have months’ worth of pay slips, invoices of items and services that will usually make up your budget list, receipts of cash payments to vendors, and bank statements, if possible.
Assuming you are budgeting for an upcoming calendar month, start by looking at your previous month’s take-home pay.
If you are paid monthly or semi-monthly, this will be easy.
If you are paid semi-monthly, multiply your paycheck by 2.166 to determine your monthly pay.
Paid weekly? Multiply your check amounts by 4.333.
Budgeting is a bit trickier if your main source of monthly income varies (if you are paid hourly and work variable hours, get paid for services you render or earn tips), you can average several months of income or estimate based upon experience. But be conservative. In a month’s time you want to have spent less than you planned for in your budget—a difficult goal when you don’t bank as much cash as you thought.
You also want to take other income sources into account.
Will you get a bonus next month?
Do you pick up menial jobs once in a while or sell (old) stuff from time to time?
Do you have any investments paying dividends?
Do you occasionally get grants or monetary gifts from friends or family?
Create entries in your monthly budget for these additional income sources and create a line for your total monthly income. This is the amount you have to spend for the month and the basis for your “spending plan”. You cannot spend more than this in any one month. If you anticipate unusually large expenses next month for which you have money saved (a ceremony, a vacation, for example), consider including the savings/source of funding you will use to pay for the expense as income. This will allow you to see a more typical monthly spending plan despite the inclusion of a non-monthly expense.
For your monthly budget to work, your expense projections need to be as accurate as possible. Some expenses, like your rent, car maintenance, phone/internet bill, water/electricity expenses are simple. From there, it gets trickier.
Chances are your utility bills fluctuate from month to month and how much you spend on food stuffs, eating out/refreshment, and clothing may vary drastically. Here’s where having a few invoices, previous expenses notes and bank statements will be useful so you can average several months’ worth of data.
Place each expense on a line and write down the amount next to it. You may find it useful to create categories of expenses like:
Consider expenses that may not be monthly, such as clothing or car maintenance. You should still budget for these items. If you allocate money every month for these things, that money will be available when you do need it.
Tracking and estimating your monthly expenses will be harder, but not impossible, if you frequently pay in cash. While cash is a good way to moderate your spending, you need to be diligent about collecting receipts if you want to know where your money went. A new benefit of credit and debit cards now is that you can use them virtually everywhere, even for micro payments of just a few amount, and also at the end of the month you get a statement with all of your monthly expenses on one page.
Your Bottom Line
When you have a complete list of your monthly expenses, add them up and subtract the sum from your monthly income. You should have a positive number. If no then you can’t keep spending according to this budget, or else you are going into debt. You will need to find out why your expenses exceed your income and find ways to cut your expenses – fast! Look at your list of expenses and separate discretionary (unplanned) spending that you often indulge in. This may include entertainment, impromptu shopping, travel, gifts, and all dining out (including lunches!) Most people can cut their monthly expenses significantly by learning to give up small daily expenditures like soft-drinks or snacks.
If your budgeted expenses fall below your income, congratulations! You are successfully living below your means. The question, now, is how to use your extra money.
Finally, Keep It Simple
If you ever want to build wealth and stay out of debt, you have to spend less than you earn. And a budget can ensure that you do that. Still, rigidly tracking every dime you spend is like watching your weight — it sounds good in theory, but most of us fail to keep up with it.
But you can stick with a budget if:
You keep your budget as simple as possible.
You harness the power of automating your money: we humans are emotional, easily tempted, and lazy. We do stupid stuff with money. Therefore, the single most important thing you can do for your finances is to put your money on autopilot. Start by transferring a percentage of your income to a savings account as soon as you get paid. Then, setup all of your bills to be paid automatically by their due date either electronically or otherwise.
After you get a handle on your budget, you’ll be able to focus on other priorities like getting out of debt, building emergency savings, and begin to save for retirement. They aren’t the most exciting financial goals of your lifetime, but once they are out of the way they provide solid footing for financial security for the rest of your life.