Budgeting

A Financial Beginnings Financial Education Program

What is a Budget?

Simply stated, a Budget is a summary of your planned expenses compared with your planned income, for a pre-defined time period (such as the next month or next year). The primary purpose of a budget is to help you accumulate savings and avoid unnecessary or unplanned debt. An item related to budgeting is a financial plan, which involves setting specific goals (i.e., buy a house in five years) and identifying the means for accomplishing these goals.

An important point to remember about budgeting: personal budgeting techniques/tools are generally straightforward and uncomplicated, which means that success is more dependent on discipline and attention to detail rather than on understanding some budgeting methodology.

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Budgeting

Chapter 1

WHY DEVELOP A BUDGET

If your future spending is limited to moderately small expenses (such as the cost of an iPod or a weekend trip to the coast), then creating a budget may not be a priority. However, for most people, this is unlikely and impractical.

It’s far more likely that you’ll have to deal with some or all of the following types of (larger) expenses:

  • Purchasing a car
  • Paying for college
  • Purchasing a house/condo
  • Saving for retirement

The cost of these items can range from $25,000 to over $100,000, and together they could easily exceed $500,000 when taken in combination. The probability of accumulating this level of savings without some sort of roadmap (i.e., budget, financial plan) is low.

Additionally, the prospect of dealing with savings, budgeting, and investing is realistically unavoidable:

  • 50% of households own stock (many through retirement plans).
  • 90% have bank accounts.
  • 100% have bills.

Case: Cheryl

Cheryl, a single parent, has two children, ages 5 and 9. She works as a receptionist and makes $26,000 a year. Cheryl pays $700 a month in rent for her two-bedroom apartment.

Cheryl was unemployed for a few months before she found her job, and during that time she rang up $2,200 in credit card debt. Her credit card APR is 24.99%. Even though it’s a struggle to pay the credit card bill, Cheryl always pays it on time.

Cheryl’s kids have two good friends in the neighborhood, Danny and LaTonya, and when they come over, Cheryl often ends up feeding all the children dinner and taking care of Danny and LaTonya until their parents get home from work.

Cheryl’s office is in a downtown shopping area, and she likes to stop in at her favorite clothing store during her lunch break. While she usually waits until items she likes are on sale, sometimes she makes an impulse buy using her credit card, even though the item may not be on sale.

Cheryl is planning to take her kids on vacation in three months to visit their grandparents in another state. She needs to save about $1,200 for the plane tickets and travel costs.

What are some ways that Cheryl can cut down on her expenses so that she can afford to take the vacation with her family?

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Chapter 2

BUDGETING FRAMEWORK

There are four basic elements in a budget:

  • Income sources
  • Expense items
  • Surplus (+) or shortfall (-) calculations
  • Time horizon (i.e., one month, six months, one year or greater)

 

Types of income

Income can be created in various ways. Below are some examples of different types of income sources.

Earned income

  • Working a job (earning a salary)
  • Consulting for another company
  • Owning a business

Portfolio income

  • Trading or selling paper assets (stocks or bonds)
  • Buying or selling real estate
  • Buying or selling physical assets (antiques)

Passive income

  • Rental income
  • Interest
  • Royalties from intellectual property (books, patents)

 

Types of expenses

In many cases expenses are other people’s form of income. It is just as important to understand our expenses so that we can find ways to minimize them to fit in our budget. Below are some examples of different types of expenses.

Fixed expenses do not change from one time period to the next. This means that every month you can almost guarantee that the cost will be the same as it has been.

Examples of fixed expenses are:

  • Rent
  • Car payment
  • Loan payments
  • Internet bill
  • Phone bill (assuming you do not go over on data)

 

Variable Expenses can change from one time period to another. For example, spending the same amount on groceries from month to month is very unlikely, so we consider them a variable expense. Variable expenses are more controllable than fixed expenses in the short term. However, even fixed expenses can be reduced. For example, you can refinance your home mortgage at a reduced rate or get a less expensive car with lower monthly payments.

Examples of variable expenses are:

  • Groceries
  • Entertainment
  • Clothing
  • Gas
  • Income tax

Taxes

As you probably noticed, taxes are included in both fixed and variable expenses. The reason is that there are different types of taxes that are dependent on the situation.

Property tax, a fee charged by the government based upon the estimated value of the property, is unlikely to change during the year. Income tax, a fee imposed by the government based upon the amount of income a person makes, is most likely variable because the tax is dependent on the income made. This can be flexible if the individual has multiple, various, or variable sources of income.

Chapter 3

TYPICAL ITEMS IN A BUDGET

While each budget is unique there are common items we all spend money on, below is a list of those common items:

  • Automobile (car payments, maintenance, etc.)
  • Child care
  • Clothing
  • Communications services (cell, Internet, cable TV)
  • Contributions or donations
  • Entertainment
  • Food (groceries, restaurants)
  • Gifts
  • Housing (rent, mortgage payment, home repair)
  • Insurance (car, home, health/medical)
  • Loans (student loans or personal loans)
  • Medical (insurance, co-payments, medication)
  • Taxes (state, federal)
  • Other transportation (mass transit, taxicabs)
  • Utilities (electricity, natural gas)
  • Vacations

Even though savings is not technically an expense item, many people view it as one. This lends to the term "pay yourself first". You don‘t necessarily need all of these items in your budget, but you do need to make sure to capture your expenses in major categories. Also, make sure that your budget fits your needs.

Chapter 4

SETTING GOALS

Goal setting involves setting goals (e.g., buy a car), setting a timeline for when you would like to achieve these goals (e.g., in two years), and identifying the means for accomplishing them (e.g., I will set aside $300 a month for the down payment).

Setting specific financial goals ensures that your income and expenses are in line with what you may want and need. Otherwise, you can end up consistently short of the cash needed for large (predictable) expenses like a house, a car, tuition, etc.

 

To start:

  • Pick a time period to cover—one month, one year, etc. For someone with limited budgeting experience, a one month or per

paycheck period is a good place to start.

  • Identify your expected expenses in each area (food, rent, etc.), along with your planned income.
  • Enter the data into a table and compare your income vs. expenses, with an objective of having your income exceed your expenses. Online or software programs for budgeting can simplify this process, or even using a spreadsheet can help in laying out a budget.

In general, personal budgeting emphasizes total income vs. total spending. However, for some planned expenses (i.e., new car, college, and house), there is a need to be more specific with your financial goals and how they will be achieved.

 

For these items, you need to generate a specific plan that includes:

  • Stating your goal.
  • Determining when you want to achieve the goal by.

- Short-term–under 1 year

- Long-term–longer than 1 year

  • Determing a cost.
  • Creating a plan to achieve the goal.

Chapter 5

HOW TO FORECAST ITEMS IN YOUR BUDGET

Your budget will be most useful when it contains reasonably accurate and complete information. Some of the ways that you can capture and summarize budget data include the following:

  • Keep a notebook. Write down everything you buy and every bill you pay.
  • Keep all of your receipts in an envelope, shoe box, etc. to be summarized later.
  • Create a computer file to track your income and expenses. There are a variety of software tools that can be used to help develop and manage a budget, including: Quicken, Mint, BankTree, You Need a Budget (YNAB), Budget Express, etc. You can also use a generalized spreadsheet program such as Microsoft Excel to forecast and track budget items.
  • Many banks and credit unions offer online budgeting tools as part of their online banking platforms.

 

NOTE: While drafting a budget is an important first step, budget revisions are just as important as the original budget. Many people make a budget and then forget to revisit it to make updates as needed. Remember to use it as an ongoing financial roadmap.

Chapter 6

TOOLS TO MANAGE YOUR BUDGET

Focus on Major “Cost Drivers”

In order to have the maximum impact on spending reduction, you should focus first on the big “cost drivers”, or the categories or items where you spend the most. For example, it‚ s likely that a 5% reduction in your grocery dollars will reduce your overall spending much more than a 50% reduction in magazine subscriptions, so take a look at your larger budget line items first.

“What-If” Budgets

Budgets are forecasts of your money for the future. Because of the uncertainty of a forecast, it may be worthwhile to look at a few different budgets, each tied to different assumptions around major shifts in income or spending. These are called “what-if” scenarios and could involve items like the following:

  • A new job pays much more or much less than expected.
  • Uncle Fred gives you his car and now you don‘t have to buy one.
  • You change to a much less expensive cable TV, cell phone, and internet plan.

Use specific techniques to reduce spending:

There are numerous, proven techniques that are often effective in keeping expenses under control. For example:

  • Groceries—Use store brands vs. national brands; shop at low-cost retailers; don‘t shop when you‘re hungry
  • Transportation—Combine insurance policies (like home and auto) under a single provider; buy used cars vs. new cars
  • Entertainment—Use restaurant discount offers; take off-season vacations
Want to Learn More?

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Climbing out of debt takes having a plan. Learn how to use your budget to pay off your debt in this module.

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Chapter 7

Final Jeopardy!

Congratulations on finishing the course! Now it is time to test what you've learned in a game of Financial Footings Jeopardy! Pick your teams and answer questions from the information you've learned in this course. The team at the end with the most points wins!

Start the Game!

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Budgeting