Setting Budget Priorities – Balance Sheet
Article by R. Joseph Ritter, Jr. CFP® EA
There is one other tool we can use with a budget, and that is the balance sheet. The balance sheet is simply a list of everything you own and everything you owe. At the end, you subtract what you owe from what you own to determine your net worth.
Why is this important and how is it used?
The balance sheet helps you see whether you can use savings to pay for a budget shortfall and helps you know what priorities to set. Let’s look at an example.
|Checking Acct||$500||Credit Cards||$3,500|
In this case, we know that there is $22,500 of short-term debt which needs to be paid (car loan, credit card and student loan). We also see that this person only has about $1,500 cash on hand.
When we prepare our budget, we know that we have to factor in these items, right?
- We have to allocate something to pay down debt.
- We have to make sure no new credit card debt is added.
- We have to beef up savings.
How do you know how much savings you need? The discussion on emergency funds is a good starting point, so that you have money set aside when life does not go according to budget. Besides that, it is very helpful to begin thinking about the most expensive things that you will face at some point. A new roof on the house, a new transmission in the car, new appliances in the house.
If you’re not prepared for them, what happens? The bill goes on the credit card, and then you’re left wondering how to pay it off, right?
A very simple approach to tackle these big bills is to use a sinking fund. Here’s how it works:
|Cost of a new roof||$5,000|
|Lifespan of existing roof||7 years (84 months)|
|$5,000 / 84 months = $59|
To fund a new roof in 7 years, you would add a line in your budget for “roof,” and each month for the next seven years allocate $59 to the “roof” fund. This money goes into a separate savings account and sits there, untouched, until the roof needs to be replaced.
This makes replacing the roof manageable, right? And you no longer need to sit up at night worrying about how you will pay for things. Everything that costs more money than you have on hand can be funded through a sinking fund. Just repeat this process for each one, and this will help to set the priorities for your budget.