Budgeting What It Is, How It Works and Why You Need It
Budgeting is an essential part of proper money management. Proper money management is a vital first step toward reaching your financial goals. If you don’t know where your money is going, you may never be able to save enough to retire, send the kids to college, or enjoy the lifestyle you want.
When it comes to budgeting, the hardest part is getting started. Once you have that budget in place, you may wonder what took you so long, or how you managed to live without a spending plan for so long. A comprehensive household budget gives you the ability to monitor and control your cash flow, making it easier to weather the inevitable financial storms and handle those inevitable unexpected expenses.
Budgeting used to be a lot more difficult and tedious than it is today. Advances in technology have made managing money easier than ever before. If you have been putting off creating a budget because you thought it would be too hard, just fire up your spreadsheet program or go online to download a budget template.
You will find that categorizing, and ultimately controlling, your spending, can be easier than you ever thought possible.
Once you have that basic budget template in place, you can start to enjoy the advantages of having a household spending plan in place. With a budget, you can:
- Control your cash flow
- Manage your expenses
- Create and maintain a realistic schedule for paying bills
- Avoid late charges
- Manage your finances and prioritize your debt repayment
- Find ways to cut expenses and free up cash flow
You can find a variety of valuable tools to create a budget on the internet. These tools can make creating and managing your budget a lot easier. Getting started is the hard part. Once you have a budget in place, you’ll have to put in a lot less work going forward.
No matter how you go about it or which tools you use, your budget will be the road-map to effective money management. You can make your budget as basic, or as complex, as you wish - the most important thing is that it meets your needs and the needs of your family.
Your budget may only have six lines listing your income and basic expenses, and that’s fine. If you need to delve deeper, you can break up your spending into dozens of categories. A more detailed budget makes it easier to spot and correct overspending.
Whether you choose a simple or a more detailed format, the steps to start your budget are the same.
- Add up all your monthly income, including all sources of income
- Categorize your expenses, including both essential and non-essential spending. These are the basic categories of expenses.
- Fixed expenses - Fixed expenses - like rent or mortgage payment, health insurance, car insurance and so on – are the exact same every month.
- Flexible expenses - Essential spending that varies each month include things like your electric bill, groceries, phone bill, etc.
- Discretionary expenses - These are wants, not needs, and include things like dining out, buying new clothes, getting the latest tech gadget, etc.
- Subtract your total expenses from your total income. Assess your cash flow and make sure it is positive, i.e. your income is high enough to cover your expenses with money left over
- Set your priorities, including debt repayment, saving for retirement, building an emergency fund, etc.
Smart Budgeting Tips
Building a budget is an essential first step toward getting your finances under control and paying down debt. Creating a budget is not easy, but once that spending plan is in place, maintaining it could be simpler than you think.
There are some basic guidelines to make budgeting, and monetary decisions, easier. Many experts recommend these guides to help their customers take control of their finances.
- Total debt payments, including credit card payments, mortgage payments and car payments, should add up to no more than 36% of your monthly household income. Anything over 36% can make handling debt difficult or even impossible.
- Credit card debt payments should take up no more than 10% of your monthly income. If you can free up additional cash to pay down your credit card debt, you can improve your finances much quicker.
- Use a three-month average to set your spending targets. Spending in certain categories can spike in a single month, so it is best to use a three-month average to set your spending and saving goals.
- Treat savings as just another budgeted expense. This is known as the pay yourself first strategy, but no matter what you call it, your savings should be another line on your budget. You should try to save 5-10% of your income. If you can’t afford that much right away, start with a smaller amount and ramp up the amounts over time until you reach your 5-10% goal.
- Trim discretionary expenses first. When it comes time to cut back, discretionary expenses should be the first to go. From limiting restaurant meals to once a month to cutting back on your wardrobe expenses, there are plenty of ways to save.
Creating a comprehensive household budget is never an easy thing to do, but it is an important one. When it comes to budgeting, getting started is often the hardest part, but there is no reason to put it off any longer.
If you are tired of living without a plan and ready to get started on your first budget, you can download a great budget worksheet here.