How to make a budget
Oran Hall, Personal Financial Advisor
A budget is a detailed statement of the sources and amount of all income and of how that income is spent in the reporting period. It is a useful tool to manage money, and it enhances the prospects of realising financial goals.
Ideally, a budget should be made to match the natural inflow and outflow of income, so a monthly budget is best for persons who receive a monthly income, but income and expenditure should not necessarily be expected to be the same for all months.
For a full picture of the inflow and outflow of funds, a budget should be crafted for the full calendar year broken out by month in this case.
It is advisable to establish a pattern of spending and earning in order to determine how much should be budgeted for each item before the exercise begins. On the spending side, a good idea would be to record all spending for at least three months; persons who use credit cards have the advantage of receipts and credit card statements, which are convenient means of identifying spending. Bank statements are also useful means of identifying spending.
Persons who do not have the above means of determining the ways in which they spend should secure all receipts and also make a written note of all of their spending.
Salary advices are useful for tracking income, but statements showing other forms of income are also important. Such income need not be allocated to spending, but could be allocated to savings, investment or debt reduction.
So as not to miss any item of spending, it is critical to identify periodic expenses such as insurance premiums and school fees, which fall outside of the period being used to establish the level and pattern of spending. In fact, generally, records from previous years, if available, should be employed as it is critical to get it right if the budget exercise is to have real meaning.
It is very important to group related expenses. For example, all expenses related to operating a motor vehicle can be grouped together. The following could fall under the heading, 'Motor Vehicle Expenses': insurance, maintenance, fuel, licence and registration, loan repayment - if there is a loan directly related to the motor vehicle.
One good reason for this approach is that it makes it easier to identify the areas that are troublesome to the budgeting process. If, for example, the motor vehicle expenses segment of the budget regularly overruns the budget, it sends a signal that either the budgeted expenses are understated or that enough effort is not being made to control those expenses.
And it would be necessary to take corrective action either by recasting the budget with more realistic figures or by reducing expenses. It could even suggest that it is time to acquire a more economical motor vehicle.
For more effective management of the budget, it is advisable to be clear about the various types of expenses. Fixed expenses generally do not change much and include rent or mortgage and insurance premiums. Variable expenses are those that change from period to period or with usage and may include food and utility charges. It is possible to make some variable expenses fixed by capping them.
Required expenses are those necessary to the maintenance of a basic lifestyle. Food is a good example. The opposite is discretionary expenses, which may be reduced or eliminated without doing serious harm to one's basic lifestyle. Entertainment and gifts are good examples.
Recurrent expenses tend to be incurred on a regular or day-to-day basis. Food and utility charges are good examples. On the other hand, periodic expenses tend to be made at quarterly, semi-annually or annually, or at other intervals. To manage these effectively, it would be prudent to set aside a portion of the required sum each month or at some other interval to obviate the need to find all of the required sum at the due date of the payment.
In setting up the budget worksheet, there should be a column for the budgeted amount, one for the actual amount and one for the variance, that is, the difference between what was budgeted and what was actually realised. This applies both to income and expense. Where this approach is taken, individual items such as food at home and mortgage should each be entered on one line under the appropriate heading - food and housing, respectively.
For the budget to be useful, an accurate record must be made of each item of actual income and actual expenditure for the budget period, so record-keeping is critical. The dollar value of the items should be added and the totals for each group of items entered into the worksheet before the final calculations begin. Persons who have access to computers, smartphones and tablets may access available programmes to make it easier to manage their budgets.
Some persons tend to allocate a certain percentage of their income to specific items. The danger in this approach is that their spending tends to increase as income increases. The opposite approach of setting a dollar figure for each item seems more useful to me. It makes it easier to keep a lid on spending and it is far easier to know how much there is to spend.
Using fixed dollar amounts in the budget does
not preclude the calculation of the percentage of the budget that is
spent on particular items. In fact, a column can be added to facilitate
this. At the end of the exercise, the result no one should want to see
is expenditure exceeding income.
Oran A. Hall, a
member of the Caribbean Financial Planning Association and principal
author of 'The Handbook of Personal Financial Planning', offers
personal financial planning advice and