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CHARACTERISTICS OF SUCCESSFUL BUDGETING
Having a spending plan will not eliminate financial worries. A budget will work only if you follow it. Changes in income, expenses, and goals will require changes in your spending plan. Money management experts advise that a successful budget should be:
Well planned. A good budget takes time and effort to prepare. Planning a budget should involve everyone affected by it. Children can learn important money management lessons by helping to develop and use the family budget.
Realistic. If you have a moderate income, don't immediately expect to save enough money for an expensive car or lavish vacation. A budget is designed not to prevent you from enjoying life but to help you achieve what you want most.
Flexible. Unexpected expenses and changes in your cost of living will require a budget that you can easily revise. Also, special situations, such as two-income families or the arrival of a baby, may require an increase in certain types of expenses.
Clearly communicate. Unless you and others involved are aware of the spending plan, it will not work. The budget should be written and available to all household members.
MONEY MANAGEMENT AND ACHIEVING FINANCIAL GOALS.
Your personal financial statements and budget allow you to achieve your financial goals with:
- Your balance sheet: reporting your current financial position - where you are now.
- Your cash flow statement: telling you what you received and spent over the past month.
- Your budget: Planning, spending and saving to achieve financial goals.
People commonly prepare a balance sheet on a periodic basis, such as every three or six months. Between those points in time, your budget and cash flow statement helps you to measure spending and saving activities. For example, you might prepare a balance sheet on January 1, June 30, and December 31. Your budget would serve to plan your spending and saving between these points in time, and your cash flow statement of income and outflows would document your actual spending and saving. This relationship may be illustrated in this way:
Changes in your net worth result from cash inflows and outflows. In periods when your outflows exceed your inflows, you must draw on savings or borrow (buy on credit). When this happens, lower assets (savings) or higher liabilities (due to the use of credit) result in a lower net worth. When inflows exceed outflows, putting money into savings or paying off debts will result in a higher net worth.
IDENTIFYING SAVING GOALS
Saving current income is the basis for an improved financial position and long-term financial security. Common reasons for saving include:
- To set aside money for irregular and unexpected expenses.
- To pay for the replacement of expensive items, such as appliances or an automobile, or to have money for a down payment on a house.
- To buy special items such as home video or recreational equipment or to pay for a vacation.
- To provide for long-term expenses such as the education of children or retirement.
- To earn income from the interest on savings for use in paying living expenses.
SELECTING A SAVING TECHNIQUE
For many years, the United States has ranked lowest among industrial nations in savings rate. Low savings affect personal financial situations. Studies reveal that the majority of Americans do not have an adequate amount set aside for emergencies.
Since most people find saving difficult, financial advisers suggest these methods to make it easier:
- Write a check each payday and deposit it in a savings account not readily available for regular spending. Or, use an automatic payment to electronically transfer an amount to your savings. This savings deposit can be a percentage of income, such as 5 to 10 percent, or a specific dollar amount.
- Payroll deduction is available through most places of employment. With this system, an amount is deducted from your salary and deposited in savings.
- Saving coins or spending less on certain items can help you save. Each day, put your change in a container. You can also increase your savings by taking a sandwich to work instead of buying lunch or refraining from buying snacks or magazines.
How you save is far less important than making regular periodic savings deposits that will help you achieve financial goals. Small amounts of savings can grow faster than most people realize.
CALCULATING SAVINGS AMOUNTS
To achieve your financial objectives, you should convert your savings goals into specific amounts. Your use of a savings or investment plan is vital to the growth of your money. Using the time value of money calculations can help you calculate progress toward achieving your financial goals.
SUMMARY OF OBJECTIVES
Objective 1
Recognize relationships among financial documents and money management activities.
Successful money management requires effective coordination of personal financial records, personal financial statements, and budgeting activities.
Objective 2.
Design a system for maintaining personal financial records.
An organized system of financial records and documents is the foundation of effective money management. This system should provide ease of access as well as security for financial documents that may be impossible to replace.
Objective 3.
Develop a personal balance sheet and cash flow statement.
A personal balance sheet, also known as a net worth statement, is prepared by listing all items of value (assets) and all amounts owed to other (liabilities). The difference between your total assets and your total liabilities is your net worth. A cash flow statement, also called a personal income and expenditure statement, is a summary of cash receipts and payments for a given period, such as a month or a year. This report provides data on your income and spending patterns.
Objective 4.
Create and implement a budget.
The budgeting process involves four phases: (1) assessing your current personal and financial situation, (2) planning your financial direction by setting financial goals and creating budget allowances, (3) implementing your budget, and (4) evaluating your budgeting program.
Objective 5.
Relate money management and savings activities to achieving financial goals.
The relationship among the personal balance sheet, cash flow statement, and budget provides the basis for achieving long-term financial security. Future value and present value calculations may be used to compute the increased value of savings for achieving financial goals.
Calculating gross monthly income
To calculate the gross monthly income, all of the revenue that is earned within a month has to be summed up. Whether the income is coming from work, disability, bonds, investments, or unemployment, all of it has to be included. However, when figuring out the proper gross income from each source, make sure that the value is really the gross, and make sure that the number is represented on a monthly basis.
First, the gross income has to be the revenue that is earned prior to any deductions such as taxes, medicare, insurance, etc. Second, if the income source is not received on a monthly basis, but rather every two weeks or on any other interval, the revenue will have to be converted to a monthly basis.
Calculating monthly net income
Net monthly income is the revenue that is left after all of the monthly deductions have been subtracted; meaning monthly gross income minus taxes, insurance, medicare, and other deductions. In calculating the net monthly income, make sure that all sources of income are included and that their net incomes are on a monthly basis. Here is an example of how to convert a paycheck that is for a two-week period to a monthly basis. First convert the two-week paycheck to a weekly paycheck by dividing the net income by two. Then multiply that figure by 52 weeks to get the annual net income. Afterwards, divide that annual net income by twelve to get the monthly net income.
The Problem Is Not In Your Income, But In Your Expense.
A lot of people blame their low income for their financial problems. However, the truth of a matter is that most likely you have enough income. The problem is your expenditures. The choices that you made and the lifestyle that you have chosen for yourself has probably put you in this position. The choice of living well today while ignoring the future is what brings most people into financial distress.
Analyzing Expenses
One of the most important aspects of personal finance is expenses. To truly understand where, how much, and for what these expenses are accruing, it is necessary to track down where the current expenditures are going. To calculate your expenditures, you can look at your past credit card statements and checkbook expenditures for the last six months. Another method to calculate your expenditures is by keeping track of what you spend every month for six months. For either approach, you need to list who the payment was made to in one column, the amount of money that was paid in the second column, and the category of the expenditure in the third column. At the end of the month, the total amount spent should be calculated in addition to the total spent in each category. Afterwards, the totals in each category should be calculated in terms of total percentages spent for that month. To perform that calculation, the total in each category needs to be divided by the total monthly expenditure.
Taking Action
After looking at the expense chart, analyze which sections are too big. These are the areas you need to work on. If the gift section is too big, that means that you need to decrease your spending on gifts. The fact that this expenditure may be gifts for others should not dissuade you in decreasing this expense. You should not be spending money on gifts when you do not have the money.
There may be some peer pressure that will force you to spend. However, it is up to you to face these pressures and decrease your expenses. In addition, it is necessary to realize that all of the expenses are optional. It is optional to have cable, to have a gym membership, and to go out to restaurants.
Willingness to Adjust Budget: Adjusting Expenses
Life is full of changes. Children are born, houses are bought, injuries and sicknesses that require hospitalization arise. All of these events represent additional expenses. Furthermore, people's incomes change. People get laid-off, change careers, or choose to go back to school. All of these changes in life demand that we are willing and capable of adjusting our budgets.
A flexible budget that can be easily adjusted can only be accomplished by having a low amount of fixed installment payments. Having a large amount of installment payments prevents you from being able to adjust to life events. However, in addition to having the ability to change your expenses, you also have to be willing to change. Often times, when people get laid-off (decrease in income), have children (increase expense), or buy a new house (increase expense), they are unwilling to change their expenses. A person may have gotten laid off but still continues to shop for the newest clothes. Such behavior hinders the whole purpose of having adjustable expenses. It is necessary not only to have adjustable expenses, but to also realize when an adjustment to these expenses is necessary and to actually make the adjustment.
Capability of Adjusting Budget: Commitment of Income
At some point in everybody's life there is no debt, no commitment to payments, and no excruciating stress that comes with a devastating financial situation. However, for some, a day may come when they find themselves overwhelmed with debt. They are surprised to find themselves in this situation, since everything seemed just fine not too long ago. They try to find faults within their current actions, to explain what happened that caused this situation. Most of the time, everything that happened right prior to the turning point was nothing extraordinary; leaving one to think that their fate was to fail financially. In reality, the reason why some people can't see their mistakes is because the financial mistakes are often made long before they ever show their symptoms.
Problem lies in the current commitment of future income without proper analysis of the side effects. There are multiple ways in which people every day commit their future income for a period of years. Everyone has a limit of what their annual salary is. Purchasing items using installment payments (including credit cards), commits the buyer's future income to these payments. At the point of purchase, the buyer's financial situation is changed, even if the buyer is unable to see or sense the change. Purchasing a car with installment payments for the next five years of $350 decreases the buyer's income for the next five years by $350. This means that the buyer will have $350 less to spend on anything else. Often times, people commit their income to the point of where there is no income left after all of the regular expenses and installment payments.
Such commitment has enrooted assumptions and risks. First, the buyer has to keep his income at current levels or higher to be able to make all of the installment payments and current expenses. If the buyer all the sudden loses his job, or has less income, he won't be able to make the payments on the car or on other expenses. Second, the buyer has to keep his expenses at the same level; since increasing expenses will cause him to spend more than he earns. These limitations on income and expenses will bound the buyer to his current lifestyle for the next five years, since all of his current income would already be tied up. This means that the buyer can't move into a more expensive house, have more children, nor take more vacations. Furthermore, any fluctuation in events, such as getting sick and not working for a week, buying an expensive present, or any other event can cause the debtor to incur an expense that can't be covered with the income. Is it realistic that within five years the buyer won't experience any of the described occurrences?
Any significant change in events will cause the buyer to enter into new debt, which might be the beginning of the turning point. If the buyer's television breaks in three years, the buyer may purchase a new television for $600. However, there isn't $600 left in the buyer's budget. The only option is the use of credit cards or installment payment loan financing. This is how it starts. The debtor can't afford the new installment payments, or the credit card balance, causing more debt to accrue due to interest. There are many other events that will cause the buyer to need some of his income, and all of the sudden the buyer finds himself buried in debt. Looking back at recent purchases, the buyer may not see any mistakes. However, the true mistakes lie in the long term installment payments.
When committing future income, the best case and worse case scenarios have to be looked at. By making the purchase, the buyer decreases his discretionary income. The best case scenario demands the buyer to keep his current lifestyle, without being able to spend an extra dime on anything else. The worst case is the debtor can't keep the purchased item due to seizure by the creditor. Commitment of income should be carefully analyzed due to its long term nature of decreasing the buyer's discretionary income. Such decrease in discretionary income decreases the ability to effectively deal with life changes. If most of the income is not tied up with installment payments, then should something unexpected come up, the discretionary income can adjust to the event; by decreasing expenditure on some things while providing more of the income for the new necessity.
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