By DoughMain Financial Literacy Foundation
Stated simply, a budget is a plan reflecting your income and expenses. Many people ask the question “Where does all the money go?” or “How am I ever going to afford….?” A budget will enable you to answer the “Where” question, and help you answer the “How”. Once you understand how your money flows, you gain an element of control over your financial life. Budgeting often points out specific areas where you have more flexibility and control over spending than you may have assumed. This understanding makes it possible to make more informed decisions regarding your saving and spending priorities. It also makes it more likely you will attain your financial goals. This article explains how to budget and reap its benefits.
Understanding Your Money
Income is money you receive. Most people receive income on a bi-weekly or monthly basis. If your income is stable - such as a regular salary or other payment - then budgeting for income is relatively easy. If it fluctuates - for example, if you receive your income in the form of commissions or periodic bonuses, then it is a little more complicated. In those cases, you need to assess how predictable your income is. Rather than guess, you can track it historically and use an average to project what you can expect in the future. Be careful, though. If you had a particularly good year, or received an unusually large bonus, then don’t assume you will do as well going forward. Similarly, if you earn a salary, it is best not to assume you will receive raises. Once you have a good idea of your income, you can track how your actual income compares going forward, and make adjustments up or down as your situation warrants.
Expenses represent money you spend. Some of your expenses will be relatively unchanged each month. These include items such as your rent, student loan or auto loan payments. Most will be variable, however. Utilities will change depending on how much electricity, heat or air conditioning you use. Others such as food, clothing, and entertainment will also change. The best way to get a handle on where your money is going is to track it by category for a number of months, and then use that information as a basis for your monthly budget. You can use the average, but pay attention to unusually high or low months.
The chart below is an example budget worksheet from FiKit, but you can and should use categories that meet your needs. Websites such as nerdwallet.com and moneyunder30.com provide additional examples, and there are several Google Sheets or Microsoft Excel templates available for free. While tracking your income and expenses may seem boring, the good news is that there are also several apps that make it easy. These apps track and categorize your income and spending for you. Your bank may already provide financial planning tools as part of their online services. Look for a tab that says “tools” or “financial planning” or “my financial picture.” Other services, such as mint.com, are also popular.
Using a Budget to Set and Attain Financial Goals
As you review your income and expenses, evaluate where your money goes. Many people are surprised at how much money is spent on small, incidental things like coffee or dinner out with friends. Others identify various “hits,” such as unanticipated auto repairs or dental or medical bills that set them back more significantly than they realized. As you go through the exercise of evaluating your expenses, you will likely find areas where you want to make changes to your spending habits. In fact, one of the great benefits of budgeting is it enables you to understand these habits. You will no longer need to “guess” how much you spend. Budgeting usually points out areas where you have more flexibility and control over your spending than you otherwise realized.
Once you have a picture of your historical income and expenses, the next step is to set financial goals. Goals can be anything, from planning for a vacation to saving for a car, house, or retirement. Your financial goals should reflect your personal values and interests. No two people will always have the same goals. You can have more than one goal. For example, establishing an “emergency fund” to cover three to six months of expenses is a good short term goal. Money for retirement is an example of a long term goal. If you are having financial difficulties, resolving them can also be a goal by exploring expense reductions to a level that can be covered by your income, or paying off credit card debt within so many months.
While your budget is a tool that will help you attain your financial goals, when setting goals you want to be sure they are SMART Goals.(1) SMART goals are always specific, measurable, attainable, realistic, and time-dependent. Keep the following chart in mind as you think about your goals.
George T Doran, “There’s a S.M.A.R.T. way to write management goals and Objectives.” 1981
Once you understand your income and expenses, and have established goals, you can then build a budget to meet them. Remember, too, you can have more than one goal. Let’s suppose you have the goal of establishing an emergency fund of $6000 within one year. In that case, you need a budget that will enable you to save $500 per month. If your current income exceeds expenses by at least that amount each month then congratulations, you are well on your way to meeting your goal. If not, then it is time to review your expenses to see where you can economize. A good place to start is by reviewing what you spend on entertainment, clothing, and groceries. Are you buying more shoes than you need? Do you go out to lunch everyday or would it be wiser to bring your lunch to work? Do you buy a lot of “junk food” at the grocery store? You can also explore ways to earn more money, such as a second, part time job on weekends. The important point is having and tracking your budget information enables you to make informed decisions, based on the facts of your situation.
Get into the habit of comparing your actual spending to your budget each month, and adjust it as circumstances change. Your budget provides a foundation for you to understand and better manage your financial health. Tracking progress against your budget is a discipline that helps you maintain it. It makes it more likely you will reach your financial goals.