Budgeting Fundamentals
What is a Budget?
A budget is a financial plan for the future. It provides a plan for what to do with your income.
- How will it be spent? (Rent/Mortgage, utilities, groceries, entertainment, etc.)
- Can we pay off our debt?
- Can we save some of our income?
Think of budget as an affordability calculator. It can show you what you can afford and allows you to make decisions based on this knowledge.
Financial Goals
First step to creating a budget is to determine your financial goals. It doesn’t have to be a long complicated list. It can be as simple as spending less every month.
Your goal may be to:
- save for a down payment to buy a house
- save to buy a car
- save for retirement
- save for an emergency fund
- pay off debt
Always set a timeframe to achieve your financial goals. If you are saving for down payment on a house, ask yourself how much time do you want to allocate to achieve this goal. Look at your budget and determine how long it will take you to achieve your goals.
What Are Your Spending Habits?
Figuring out where you spend your money could take a while if this is your first time building a budget.
An easy place to start is looking at your fixed expenses. Fixed expenses are constant each month, like rent, mortgage, or loan payments.
Next look at variable expenses change each month. This will include expenses like utilities, cell phone bills, groceries, gas. These are recurring expenses that you will incur each month but the bill amount changes monthly.
While fixed and variable expenses are predictable and easily budgeted there are other expenses that do not have a pattern, these are difficult to budget for. Expenses such as eating out, shopping, entertainment usually do not have a pattern and happen haphazardly. The best way to budget for these expenses is to allocate a certain amount every in month in your budget towards these expenses. While these expenses cannot be budgeted with great accuracy, by budgeting amount and sticking to that amount we can remove the uncertainty and give more control over these expenses.
Due to the amount of expenses in any given month, it is easy to lose track of your spending. An easy way to keep track is to allocate your expenses in categories. Categories can be groceries, transportation, insurance.
Create a Plan
How Much Income Do I Have?
This should be a straight forward exercise. Look at your pay stub to determine your income. While it seems easy to find your income, it is still an important exercise for budgeting. You may have different income streams throughout the year, with differing timing. Therefore, it is important to know when your cheques come in.
How Do I Spend My Money?
This is probably the most important step in building a budget. If this is your first time building a budget, then it could take a while for you to figure out your spending.
Ultimate goal of budgeting is often considered to be spending less than our income. By spending less than our income we should be able to reduce our debt, increase our savings, build an emergency fund, or better still save for retirement.
However, it is easier said than done. With increasing demands on our income there is usually nothing left over by the end of the month. The problem may lie with spending beyond our means. When we spend beyond our means it can lead to us to dip into our savings or take on debt. Taking on debt, in turn, creates another hole where our income disappears.
It should be clear by now that to get our spending under control we have to understand our finances; we have to get a clear understanding of what we are doing with our finances. Clear grasp of budgeting fundamentals is an important first step.
First of all, how are you going to allocate your income? How will it be spent? Is your income enough for your planned expenses? These are some of the questions a budget tries to answer. It is an action plan for your future, it can be for a week, month, or a year. Budgets are an important tool to allocate your income and helps keep expenses within set limits.
Why is Budgeting important?
As a budget is a financial planning tool, it will allow you to plan for your spending.
Benefits of Budgeting:
- Control: Budgeting provides control. It is a money management tool, that allows you to see how much you are earning and what are your spending habits. Having in depth knowledge of your finances can allow you to exercise more control.
- Track: Track your spending. To be able to understand your spending habits you need to keep a track of all your spending. Budgeting can allow you to track your spending.
- Prioritize: An important aspect of budgeting is that it allows you to prioritize your spending. There is only so far you can stretch your paycheck and budgeting forces you to prioritize your spending.
- Reach you Goals: Whatever your financial goal may be, it is doomed to fail without a plan. In order to succeed in reaching your goals you a clear budget plan. A budget plan has the power to help you reach your financial goals quickly.
