Budgeting

A budget is a plan that shows estimated income and expenditures for a specific period. Budgets can be made by individuals, families, businesses or other organizations, government agencies, or countries. They typically cover a given period, such as a month or year, during which they are used as a guideline for spending and saving. A budget may apply to all income and expenditures, or it may apply only to funds used for a specific purpose. After a budget is created, all applicable income and expenditures are tracked to ensure compliance with the budget.

A business or organization may make an annual budget for all of its planned operations for the year, after which executives and managers may create specific budgets based on this plan. For example, a company may create an overall annual budget that allocates $500,000 for advertising expenses, with $100,000 of that money going to a specific advertising campaign. The manager in charge of that campaign would then create a budget showing how that $100,000 will be used, to track expenditures and ensure that costs stay within the budgeted amount. Similarly, an individual may create an annual budget that estimates a specific amount for a vacation. The individual would then create another budget for the vacation itself, allocating certain amounts for travel, food, and so on, to ensure that vacation-related expenses stay within the budgeted amount. This article will focus on personal budgets rather than business or governmental ones.

Background

A budget is more than just a plan that shows estimated income and expenditures. It is a way of managing one’s money to meet one’s needs and wants. A budget can be used to set short- and long-term goals, to track spending and income, to make spending and career decisions, and to respond to emergencies and unexpected expenses.

A budget provides detailed information about the money someone earns and the money that person spends. By reviewing this information, individuals can determine whether their income is sufficient to support their spending habits or, if their spending is greater than their disposable income, whether and how spending can be reduced. They can then use this information to make career and spending decisions.

For example, a recent college graduate may be offered a job in a high-rent city. After creating a budget, the graduate realizes that 80 percent of the net pay will go to rent and transportation expenses, leaving insufficient money for utilities, food, and college loan payments. The graduate can either decline the job and look for another position in a more affordable city or accept the job and find ways to reduce housing expenses, such as renting outside the city or finding roommates to share the rent.

Setting goals and tracking spending allows people to make decisions about their purchases. For example, a person without a budget may spend freely and then wonder where all of his or her money went. That person may want to go on vacation but feel that doing so is unaffordable because he or she does not have a high income. By tracking expenditures, the person may discover that he or she spends a significant amount of money on impulse buys, coffee, and fast food. Creating a budget will allow that person to prioritize spending and reallocate money to meet a higher-priority goal, such as the vacation. The person can set aside a portion of the amount spent on these items to save for the vacation and budget the remainder for impulse buys, coffee, and fast food.

Budgeting also requires one to reevaluate purchasing decisions when expenditures are higher than net income or when an emergency or unexpected expense arises. Even the best-prepared individual may be faced with unanticipated but unavoidable expenses, such as automobile repairs following an accident, or unexpected changes in income, such as reduced work hours or loss of a job. By reviewing expenditures, one may be able to identify areas in which spending can be temporarily reduced or adjusted. For example, an individual might cut back on grocery spending, use credit cards instead of cash for daily purchases, or arrange a payment schedule with a creditor until cash flow improves.

Overview

The first step in creating a budget is to gather information about one’s income and expenses. Pay stubs can be used to identify workers’ net income, or take-home pay. For income from other sources, collect documents that show this income as well. An individual’s yearly income should be calculated and then divided by twelve to show the monthly amount.

Gathering information about expenditures involves tracking all purchases for a month or two to identify the nature and amount of all expenditures. This information is then used to estimate a monthly amount for each spending category.

Individuals can track purchases using a variety of methods. One method is to record the date, amount, and nature of every purchase at the time it is made. Daily purchases can be recorded with pen and paper or electronically using a smartphone, tablet, or PC. Various mobile applications, or apps, are available to facilitate the latter. Another method is to save all receipts and log them in a daily journal or spreadsheet. This method is less tedious than recording purchases at the point of purchase, but it requires supplementation for purchases that do not give receipts. These methods provide the most accurate and detailed information about daily purchases, but they rely on rigorous and accurate record keeping.

Another method of tracking purchases is to use a debit card or credit card for all purchases and then review the statements at the end of the billing period. This method shows the overall money spent every month but lacks detailed information about how the money was spent. For example, a purchase at a superstore may include groceries, sporting equipment, and cleaning supplies. The statement does not itemize the purchase, so it is impossible to identify the amount spent in each category without a receipt.

A less cumbersome method is to designate a specific amount of cash to use for miscellaneous small purchases. This method lacks details about how this portion of money is spent, but its time-saving advantage may make it worthwhile for individuals who spend relatively little on daily purchases.

After all expenses have been tracked for an appropriate period, the next step is to organize them into spending categories. The two main types of expenses are fixed expenses and variable expenses. Fixed expenses are those essential expenses that stay relatively constant from month to month. Examples of fixed expenses include rent or mortgage payments, utilities such as gas and electricity, car and loan payments, and cable and internet service. Regular transportation expenses, such as a monthly train or bus pass, are also fixed expenses. Variable expenses are purchases of goods and services that vary from month to month. Some of these items may be essential items, such as groceries, while others are discretionary items, such as vacations, entertainment, and recreation. Other examples of variable expenses include fuel, clothing, credit card payments, and gifts. Irregular transportation costs, such as train fare to visit a friend in another city, are variable expenses.

Next, the person making the budget should identify short- and long-term goals. Short-term goals include dining out at least twice a week and paying for a babysitter for date night. Long-term goals include saving money for a major purchase such as a house or car.

Once all of these preparations have been made, the next step is to create the budget. The most common budgeting method is the line-item method, in which two columns are used, one for income and one for expenditures, and all income and expense categories are listed on individual lines in the appropriate column. The estimated income is listed in the "income" column, the estimated expenses in each category are listed in the "expenditures" column, and the total amount of expenditures is subtracted from the total income. If the amount is less than zero, there is insufficient income to support the expenditures, and adjustments to spending categories need to be made in order to balance the budget and ensure that the individual has sufficient money to meet financial obligations and discretionary purchases.

This is when the individual must prioritize spending decisions. He or she must make adjustments to at least one spending category to balance the budget and meet short- and long-term goals. For example, a budget may show 10 percent more spending than income. Decreasing spending in clothing, entertainment, or travel will allow the budget to be balanced. The individual should evaluate each category, decide which categories are the least important, and adjust the estimated expenses for those categories accordingly.

After the budget is created, it should be managed to ensure that actual spending and income match the estimates. If the person’s income changes, or if spending is higher or lower than the estimated amounts, the budget will need to be revised. Managing the budget involves once again tracking one’s spending.

One way to ensure that expenses do not exceed estimated amounts is the envelope method. The amount allocated for each spending category, such as groceries or dining out, is put in a labeled envelope in the form of cash. When purchases in these categories are to be made, the cash is withdrawn from the designated envelope. Another method is to write checks or make payments for all fixed expenses, and then adjust the budget monthly for nonessentials or variable expenses.

Numerous tools are available for building and tracking budgets. For those who prefer pen-and-paper methods, budgeting worksheets can be downloaded from the internet or copied from budgeting workbooks. For those who prefer electronic methods, options include spreadsheet programs, financial management software, smartphone and tablet apps, and various online budgeting tools such as templates, trackers, and calculators.

Bibliography

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