Do I Need A Budget?
Article by R. Joseph Ritter, Jr. CFP® EA
Most major corporations operate by a budget. My church’s board requires each committee submit a budget each year for approval as part of the church’s overall budget. Watch almost any episode of the Travel Channel’s Hotel Impossible, and you will hear the host ask about the hotel’s budget.
Budgets are important to the life of an organization and are equally important in the life of the average household. Every household should have a budget. Why?
Well, let’s start with this question: How do you know how much you can spend during the coming week, month, quarter or year? Without a budget, many people spend more than they earn, and this is how credit card accounts creep up to unmanageable balances. Spending more than you earn is unsustainable and leads to financial calamity, not financial independence. After all, if someone spends more than they earn, the money for the over spending has to come from somewhere, right? Very often it comes from credit cards.
But then how do you pay off the credit cards if you are always spending more than you earn? These are all very difficult questions indeed and highlight the importance of having a budget and a financial plan.
Now that you know you need a budget, let’s define what a budget is and what should be contained in the budget.
A budget is a forecast of what you expect to happen financially in the coming period, whether it’s for a week, month, quarter or year. For household use, one year or less is recommended as the budget period. If you are new to budgeting and are not entirely sure how it works, you may want to start by writing a monthly budget to begin training yourself and adjusting your habits.
The budget begins with a statement of expected inflows, receipts, revenue or income for the period covered in the budget. Then, you list expected expenses and outflows. At the end of the budget, you subtract expenses from income, and your number should be positive. If it’s not, then you have some work to do and decisions to make. To see a sample budget, jump to the next article … but don’t forget to come back and finish this article!
Be sure to list in detail the income you expect to receive and expenses you expect to pay during the budget period. The categories in the sample budget in the next article provide a good start. Generally, if you expect to receive something or pay for something, you should assign it to a category in your budget. The key is to not have a big miscellaneous category because then you really don’t know where your money is going. Be as specific as possible to maximize the usefulness of the budget. The less specific you are in assigning amounts to categories the less you can expect from your budget.
The amount to assign to each category can be a difficult decision. Again, this is a forecast or prediction of what you expect to receive and spend during the budget period. The amount should be reasonable (not unreasonably low/high).
The goal of the budget is to guide you in keeping your outflows and expenses equal to or less than your inflows and income. Preparing a budget will help you to decide if you should stop spending in a category and eliminate it from the budget or if spending in a category can be reduced. The budget can also help you allocate money toward paying down debt or achieving a savings goal.
Work through eliminating spending in some categories and reducing forecasted spending until your outflows match your inflows.
If your inflows exceed outflows, then you have a decision to make. Inflating spending across the board in all of the outflow categories is not recommended. You may want to increase outflows in certain categories, and the two categories which should be increased are your savings, especially your emergency fund (click here to read more), and debt payments.