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BUDGETING FOR SKILLED MONEY MANAGEMENT
A budget, or spending plan, is necessary for successful financial planning. The common financial problems of overusing credit, lacking a regular savings program, and failing to ensure future financial security can be minimized through budgeting. The main purposes of a budget are to help you:
- Live within your income.
- Spend your money wisely.
- Reach your financial goals.
- Prepare for financial emergencies.
- Develop wise financial management habits.
Budgeting may be viewed in four major phases:
STEP 1: SETTING FINANCIAL GOALS
Future plans are an important dimension of your financial direction. Financial goals are plans for future activities that require you to plan your spending, saving, and investing.
Financial goals should be realistic, be stated in specific, measurable terms, have a definite time frame and imply the type of action to be taken. Your personal financial statements and budgeting allow you to achieve your financial goals with your cash flow statement: telling you what you received and spent over the past month. Your balance sheet: reporting your current financial position - where you are now and your budget: planning, spending and saving to achieve financial goals.
STEP 2: ESTIMATING INCOME
Your next step should be to estimate the available money for a given time period. A common budgeting period is a month, since many payments, such as rent or mortgage, utilities, and credit cards, are due each month. In determining available income, include only money that you are sure you'll receive. Bonuses, gifts, or unexpected income should not be considered until the money is actually received.
If you get paid once a month, planning is easy since you will work with a single amount. But if you get paid weekly or twice a month, you will need to plan how much of each paycheck will go for various expenses. If you get paid every two weeks, plan you're spending based on the two paychecks you will receive each month. Then, during the two months each year that have three paydays, you can put additional amounts into savings, pay off some debts, or make a special purchase.
Budgeting income may be difficult if your earnings vary by season or your income is irregular, as with sales commissions. In these situations, attempt to estimate your income based on the past year and on your expectations for the current year. Estimating your income on the low side will help you avoid overspending and other financial difficulties.
STEP 3: BUDGETING AN EMERGENCY FUND AND SAVINGS
Set aside money for unexpected expenses as well as future financial security. Financial advisers suggest that an emergency fund representing three to six months of living expenses be established for use in periods of unexpected financial difficulty. This amount will vary based on a person's life situation and employment stability. A three-month emergency fund is probably adequate for a person with a stable income or secure employment, while a person with erratic or seasonal income may need to set aside an emergency fund sufficient for six months or more of living expenses. You may also set aside an amount each month for automobile insurance, which is due every six months. Both this amount and the emergency fund are put into a savings account. A very common budgeting mistake is to save only the amount left at the end of the month. When you do that, you often have nothing left for savings. Since savings are vital to long-term financial security, advisors suggest that an amount be budgeted as a fixed expense.
STEP 4: BUDGETING FIXED EXPENSES
Definite obligations make up this portion of a budget. You may have fixed expenses for housing, taxes, and loan payments. Assigning amounts to spending categories requires careful consideration. The amount you budget for various items will depend on your current needs and plans for the future. The following sources can help you plan your spending:
- Your cash flow statement
- Consumer expenditure data from the Bureau of Labor Statistics
- Articles in magazines such as Kiplinger's Personal Finance Magazine and Money
- Estimates of future income and expenses and anticipated changes in inflation rates
These sources can help you budget allocations for different life situations. Although this information can be of value when creating budget categories, maintaining a detailed record of your spending for several months is a better source for your personal situation. However, don't become discouraged. Use a simple system, such as a notebook or your checkbook. This "spending diary" will help you know where your money is going. Remember, a budget is an estimate for spending and saving intended to help you make better use of your money, not to reduce your enjoyment of life.
STEP 5: BUDGETING VARIABLE EXPENSES
Planning for variable expenses is not as easy as budgeting for savings or fixed expenses. Variable expenses will fluctuate by household situation, time of year, health, economic conditions, and a variety of other factors.
The consumer price index (CPI) is a measure of the general price level of consumer goods and services in the United States. This government statistic indicates changes in the buying power of a dollar. As consumer prices increase due to inflation, people must spend more to buy the same amount. Changes in the cost of living will vary depending on where you live and what you buy.
The rule of 72 can help you budget for price rises. At a 6 percent inflation rate, prices will double in 12 years (72/6): at an 8 percent inflation rate, prices will double in only 9 years (72/8).
STEP 6: RECORDING SPENDING AMOUNTS
After you have established your spending plan, you will need to keep records of your actual income and expenses similar to those you keep in preparing an income statement.
The family's actual spending is not always the same as planned. A budget variance is the difference between the amount budgeted and the actual amount received or spent.
Variances for income should be viewed as the opposite of variances for expenses. Less income than expected would be a deficit, while more income than expected would be a surplus.
Spending more than planned for an item may be justified by reducing spending for another item or putting less into savings. However, it may be necessary to revise your budget and financial goals.
Reviewing Your Financial Progress
The results of your budget may be obvious: having extra cash in checking, falling behind in your bill payments, and so on. However, such obvious results may not always be present. Occasionally, you will have to sit down (with other household members, if appropriate) and review areas where spending has been more or less than expected.
You can prepare an annual summary to compare actual spending with budgeted amounts. This type of summary may also be prepared every three or six months. A spreadsheet computer program can be useful for this purpose. The summary will help you see areas where changes in your budget may also be prepared every three or six months. The summary will help you see areas where changes in your budget may be necessary. This review process is vital to both successful short-term money management and long-term financial security.
Revising Your Goals and Budget Allocations
What should you cut first when a budget shortage occurs? This question doesn't have easy answers, and the answers will vary for different household situations. The most common overspending areas are entertainment and food, especially away-from-home meals. Purchasing less expensive brand items, buying quality used products, avoiding credit card purchases, and renting rather than buying are common budget adjustment techniques.
At this point in the budgeting process, you may also revise your financial goals. Are you making progress toward achieving your objectives? Have changes in personal or economic conditions affected the desirability of certain goals? Have new goals surfaced that should be given a higher priority than those that have been your major concern? Addressing these issues while creating an effective saving method will help ensure accomplishment of your financial goals.
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Characteristics of Successful Budgeting