American Economics: Budgeting
A basic budget plan is knowing how much income you will have, how much money you will spend, and how much money, if any, will be left over. Using the information available to you from your check register you only know how much money is available at that moment. It doesn’t inform you of how much you will need to get through till the next payday or if there will be enough money, after paying all your bills, to allow you to make that purchase you’re contemplating.
If you were paid a fixed amount once a month there is a very easy way to budget your money. You could take a stack of envelopes and label them with the names of all the bills and expenses you will need to pay during the upcoming month. They could be “Rent”, “Utilities”,”Car Payment”, “Food”, etc. Then you would place the amount needed to pay each expense into it’s envelope. When all the envelopes had the required amounts, the money left over, if any, is the “expendable”
money that you are free to spend on non-budgeted items.
As you paid each item you would obtain the required money from the proper envelope. At the end of the month any money left in an envelope could be redistributed along with the new months income and you would be ready to start over. Using this system you would always know how much money you had available by simply inspecting the envelopes. Any deviations from the “budgeted” amounts is quickly observed and corrections could be made.
While this type of budgeting is very simple, it is not practical for most of us. First, it requires that all payments be made in cash. This alone will eliminate the plan in all but a few cases. Also, most of us have an income that is spread out, in one form or another, during the month. A weekly pay period is an example that would make the above plan very difficult to operate.
An alternative to the use of actual envelopes would be to create your budget on paper. You could project your monthly income and create accounts from which to debit or credit money as bills are paid and income is received. The sample budget below explains such a written type of budget. But for us computer users paper is old fashioned and out dated.
This is a sample budget prepared by Dick and Jane who are both employed. Dick is paid weekly and brings home a check for $350.00 each week. Jane is paid every two weeks and brings home a check for $500.00 each pay day.
Jane sometimes receives an additional amount for paid overtime and Dick receives a bonus from time to time. However, since these amounts are not guaranteed, for budgeting purposes they are not considered. If and when the extra money is received it will be added to their income at that time.
Now, if you assume that Dick will be paid four times a month and Jane will be paid twice a month, their total combined net income appears to be $2,400.00 per month. But using this assumption, as many people do, is incorrect.
During the year Dick will be paid 52 times for a yearly net income of $18,200. Jane will be paid 26 times for a yearly net income of $13,000. Their combined yearly income of $31,200, when divided by 12 (months), yields a monthly income of $2,600.00. This is $200.00 a month more than the amount figured incorrectly above.
After arriving at their total monthly net income Dick and Jane compile a list of all their known monthly expenses. Here is Dick and Jane’s list*:
Mortgage payment – – – – – – – – – – – – – – – 550.00
Auto loan – – – – – – – – – – – – – – – – – – 280.00
Auto insurance – – – – – – – – – – – – – – – – 120.00
Auto expenses (gas, etc.) – – – – – – – – – – 100.00
Groceries ($100.00/week) – – – – – – – – – – – 433.33
Utilities – – – – – – – – – – – – – – – – – – 110.00
Telephone – – – – – – – – – – – – – – – – – – 35.00
Medical – – – – – – – – – – – – – – – – – – – 30.00
Loan payment – – – – – – – – – – – – – – – – – 25.00
Life/Health insurance – – – – – – – – – – – – 180.00
Entertainment – – – – – – – – – – – – – – – – 75.00
Savings – – – – – – – – – – – – – – – – – – – 100.00
Weekly Cash ($50.00/week)- – – – – – – – – – – 216.66
Total Expenses – – – – $2254.99
*(The budget categories listed here are to demonstrate a budgeting concept and are not meant to represent a complete list of budget categories for an actual budget. The list you use will be indicative of your unique expenses.)
Subtracting the total expenses from the total monthly income leaves them with a balance of $345.00. This amount is placed into an “expendable” account (on paper) and is the amount that Dick and Jane are free to spend each month on non-budgeted items.
To manage their newly created budget Dick and Jane need to do the following:
- The first month’s budget is set up on paper showing each expense item and the “left over” amount in their expendable account.
- At each pay period the amount received is placed in a checking account. If the amount received is the exact amount that was used to figure their budget, no notation is made. However, if the amount is greater or less than the figured amount, the difference is added to or deducted from their expendable account. It is very important that they account for each pay period in this manner. For example, Jane may take a day off, without pay, resulting in a loss of $50.00 for the pay period. When she receives her paycheck she must deduct the $50.00 from the budget’s expendable account. By the same token, if Dick receives a bonus of $100.00 one week, the $100.00 is added to the expendable account. In this way their budget is compensated for the loss or gain of income.
- Once a week the weekly cash amount of $50.00, as provided in their budget, is withdrawn from their checking account. The balance of the weekly cash account at the end of any given month may end up having a balance, or be negative, depending on whether the withdrawal date occurs four or five times during the month. This variance does not need to be compensated for as it will even out over the course of the year.
- As each budget expense is paid, the amount is deducted from the item’s budgeted amount. If the amount paid is less than the budgeted amount, a balance will remain. On the other hand, if more than the budgeted amount is paid, the account will go negative (will be less than zero). For expense items that have been configured using an average amount this is the normal case. The account will have a balance when the payment is less than average, and that balance will be available when the payment is greater than average.
- Any payment for an item that is not listed in the budget is deducted from the expendable account balance. Any extra income, from any source, is added to the expendable account. The expendable account thus becomes a sort of savings account from which money can be withdrawn as needed.
- At the end of each month Dick and Jane start over with a new piece of paper. The budget is again listed, but this time each item’s budgeted amount is added to the balance left over (if any) from the previous month. If a negative balance is shown, it is subtracted from the budgeted amount and the new amount is listed. If it becomes necessary, an amount of money can be transferred by subtracting a dollar amount from any account and adding the same amount to the account needing it.
- If after several months it is noted that any budget item is repeatedly going over or under budget a correction needs to be made. The budgeted amount for the month is changed to an amount that is closer to what is actually being spent. Any change will, or course, change the amount credited to the expendable account at the beginning of each month.
- By using their budget Dick and Jane are confident in the knowledge that they will never find themselves spending more money than what they will earn. They also are aware that no budget plan can work without their commitment and diligence.
Budgeting: An In-depth Look
Budgeting, at its core, is a tool for managing money. Whether applied to individuals, families, or businesses, it’s a roadmap for financial planning that projects income and expenditures over a set period. This essay will delve into the essentials of budgeting, discussing its concepts and the reasons why it’s such a crucial skill for financial health.
Definition of Budgeting
Budgeting refers to the systematic process of allocating financial resources based on expected income and expenses. Essentially, a budget serves as a financial plan that outlines the allocation of money in different categories to meet the short-term and long-term goals, while also ensuring that expenses do not exceed income.
Components of a Budget
1. Income: This is the total money received during a specific period. It can come from various sources such as salary, interest from savings, dividends from investments, or rental income.
2. Fixed Expenses: These are expenses that don’t change from month to month, such as rent or mortgage payments, utility bills, and insurance premiums.
3. Variable Expenses: These are expenses that can change from one period to the next, including entertainment, dining, clothing, and travel expenses.
4. Savings and Investments: A portion of the income set aside for future needs, emergencies, or investment opportunities.
5. Debt Repayments: Money allocated to repay borrowed funds, like credit card bills, personal loans, or mortgages.
Importance of Budgeting
1. Financial Control: A budget helps you keep track of your spending habits. It highlights areas where you’re spending too much, or where you could potentially save.
2. Savings Goal: By planning and monitoring your expenses, you can set aside a portion of your income for savings and future investments.
3. Debt Management: Effective budgeting ensures you can meet your debt obligations on time, avoiding late fees and maintaining a good credit score.
4. Future Planning: By looking at your current financial situation, you can make informed decisions about your future, such as purchasing a home, investing in education, or starting a business.
5. Emergency Preparedness: A budget can help you create an emergency fund, which is essential for unforeseen circumstances like medical emergencies or sudden job loss.
1. Zero-Based Budgeting: Every dollar has a purpose. At the beginning of the month, the balance is zero, and by the end, every dollar is allocated to expenses, savings, or investments.
2. Envelope System: Cash is divided into envelopes for different expense categories. Once the cash in an envelope is spent, no more spending occurs in that category until the next budgeting period.
3. 50/30/20 Rule: This is a simple guideline where 50% of your income goes to needs, 30% to wants, and 20% to savings and debt repayments.
4. Incremental Budgeting: Previous periods’ budgets are used as a base, and increments are added for the new period.
Challenges in Budgeting
While the concept of budgeting is straightforward, implementing and sticking to a budget can be challenging due to:
Unforeseen Expenses: Unexpected expenses can disrupt a carefully planned budget.
Overestimation of Income: Sometimes, we might overestimate how much we’ll earn in a given period.
Impulse Purchases: Spontaneous buying decisions can derail the best budget plans.
Lack of Commitment: Without discipline and commitment, one can easily abandon the budgeting process.
Budgeting is not just a financial tool; it’s a lifestyle choice. By making informed decisions based on a well-planned budget, individuals can achieve their financial goals, prepare for emergencies, and lead a stress-free financial life. Whether you’re budgeting for personal reasons or business purposes, understanding its basic concepts and committing to the process is the key to financial wellness.
Frequently Asked Questions about Budgeting
A budget serves as a financial blueprint or roadmap that assists individuals, families, or businesses in making informed decisions about their money. The primary purpose of a budget is to ensure that one doesn’t spend more than they earn. It helps in:
Allocating Resources: A budget divides your income into various categories such as living expenses, savings, and investments, ensuring every dollar has a purpose.
Financial Forecasting: Through budgeting, one can project future income and expenses, allowing for better planning and financial control.
Prioritizing Expenditures: A budget helps you differentiate between needs and wants, ensuring that essential expenses are covered first.
Achieving Financial Goals: Whether it’s buying a home, funding an education, or planning for retirement, budgeting provides a clear path to meet these objectives.
Monitoring Financial Health: Regularly updating and checking the budget allows for the identification of potential financial problems before they become severe.
Beginning a budget from zero might seem daunting, but it’s a systematic process. Here’s a simplified guide:
List All Income Sources: Calculate your total monthly income, including salary, side gigs, dividends, or rental income.
Categorize Your Expenses: Break down your spending into fixed, variable, and discretionary expenses.
Track Every Dollar: Use apps, spreadsheets, or a simple diary to record all daily expenses.
Set Financial Goals: Define what you want to achieve, be it short-term (like an emergency fund) or long-term (like a retirement plan).
Review and Adjust: At the end of the month, compare your actual spending to your budget. Make necessary adjustments for the next month.
There could be several reasons why a budget fails:
Underestimating Expenses: Not accounting for all expenses, however small, can lead to budgetary shortfalls.
Overestimating Income: If you’re overly optimistic about your income and it doesn’t materialize, your expenses can exceed your earnings.
Lack of Flexibility: Life is unpredictable. Emergencies can arise, or sudden opportunities might need funding. A budget that’s too rigid can quickly become obsolete.
Impulse Purchases: Unplanned spending can derail even the most well-intentioned budget.
Not Reviewing Regularly: A budget is dynamic. It requires regular reviews and updates to stay relevant.
While the frequency might vary based on personal preferences, it’s generally a good practice to review your budget at least monthly. Monthly reviews allow you to:
Track your spending and see if you’re staying within the set limits.
Adjust for any unexpected expenses or changes in income.
Stay focused on financial goals and measure progress.
Make modifications for the next month based on the current month’s performance.
That said, during significant life events like a job change, marriage, birth of a child, or buying a house, immediate budget reviews might be necessary.
Sticking to a budget requires discipline, commitment, and certain strategies:
Understand Why: Recognize the reasons for budgeting, be it debt elimination, savings goals, or overall financial health. A clear understanding of the ‘why’ can motivate adherence.
Use Tools: Leveraging budgeting apps or software can make the process easier and more automated.
Limit Temptations: Minimize the exposure to impulse purchases. For instance, if online shopping is a weakness, unsubscribe from promotional emails.
Set Realistic Goals: Don’t make the budget too restrictive. Allow for occasional treats and luxuries, but within reason.
Stay Accountable: Share your financial goals with someone you trust, or consider joining a budgeting group for support and accountability.