Chapter 1: How to Make a Budget and Stick to It
Chapter 2: Creating Personal Budget Goals
Chapter 3: Assessing Your Current Financial Situation
Chapter 4: Identifying Budget Focus Areas
Chapter 5: Staying Committed to Your Budget
Chapter 6: Budget Software
An effective budget is based on an accurate assessment of your current financial state. There are many aspects involved in determining this. Your current income, current expenditure, your debt status, how much you save regularly – all these have a bearing on how your finances look at present.
Past records of your income and expenditure help in assessing your finances. Use at least a three month period as the benchmark for averaging these components. Collecting and assimilating these records can take a while so effective budgeting requires adequate investment of both time and effort.
Track Your Earnings
The first step in assessing your finances is to track earnings or income that you get each month. You may be deriving regular income from many different sources such as salary, rental property income, investments, ancillary businesses/ side business, and other similar sources. All of these have to be factored into your list of earnings.
If you have some earnings that are not predictable or regular each year, it is a good idea to divide the total annual earnings from this source by 12 to get the monthly average you stand to gain. Freelancers, consultants etc may have such non uniform earnings from their professional careers.
There may be other unexpected income or expected but non recurring incomes in any year. Such incomes may arise from ancestral property or other assets, maturing investments, bonuses at work, lotteries, unexpected salary hikes etc.
Make a comprehensive and exhaustive list of all incomes that you stand to get in any particular year. While the regular, consistent earnings should be taken into account to address regular expenditure, unexpected earnings should ideally not figure in expendable cash. These should be diverted towards fulfilling long term goals.
Tracking your income serves more than one purpose. It helps you evaluate your true earnings so that you can make an accurate comparison against total expenditure you incur. It also lets you gain an accurate perspective of what constitutes reasonable and practical financial goals given your financial status.
For example, a goal of acquiring a luxury yacht to convert into a sea bound home post retirement is not a reasonable goal for someone aged 40, employed below executive cadre.
Track Your Monthly Expenditure
Your monthly expenditure tracker should include all the expenditure incurred in the following areas:
- Monthly consumables expenses – Electricity, phone, gas, transport, groceries, and other similar expenses.
- Monthly asset building or value addition expenses – Mortgage payments, car loan payments etc.
- Annual expenses – club memberships, life insurance, medical insurance, taxes (self, property, business) etc.
- Leisure / entertainment – Vacation trips, movies, eating out, other leisure activities.
In addition to these, also have an Extras category. Here, you put in expenses that do not figure in any of the other categories, such as credit card outstanding balance interest, late payment fees, etc.
Once you have classified all your income and expenses in this manner, you have a clear idea of what comes in and where it goes.
Analyzing Your Financial State
Now assess the state of your finances.
Scenario 1: Is your income more than your expenditure per month? If so, do you save all of the difference? If you don’t, then look for expenses that are claiming the funds that ideally should be saved. Make sure that you have already factored in expenses of all kinds. Expenses that are fulfilled by potential savings are either unnecessary and can be eliminated or you have left out some critical expenses.
Scenario 2: Are your expenses overshooting your income? Then you have to trim your spending in unnecessary areas starting with the Leisure expenditure. If after cutting all the expense under this heading you still fall short, then consider cutting down on other avoidable expenses like club memberships. The next step is to cut back on electricity consumption, phone bills, saving on groceries and reducing other important expenses.
No matter which scenario you find yourself in, the Extras expenditure has to go. This is one area where you are unnecessarily spending money with absolutely nothing to show for it. Undertake a stringent debt reduction program to get rid of credit card outstanding or set up direct bank debit for recurring payments to avoid late payment penalties.
Taking proactive steps here before you end neck deep in dues goes a long way in freeing up those dollars that can make the difference between comfortable budgeting and shoe string budgeting.
The Ideal Expense Income Ratio
According to experts, your expenses should ideally claim just 60% of your total income. However, for most people this is a highly conservative estimate. As long as your income comfortably covers expenses of all nature and still lets you save a reasonable amount, you are safe from immediate debt disaster. You can use budgeting to structure, systematize and even improve your savings so that your future is financially secure.
If your expenses consistently exceed your income, then your budget needs to be more stringent and restrictive so that you can bring your financial life under control and begin to build your savings right away.