Practical Skills | Why are budgets important?

Practical Skills | Why are budgets important?

A household budget (or personal budget, if you are single) allows you to know where you are with your personal finances, and tells you if you can get where you want to go with your financial goals.

If you are in debt and want to eliminate it, or want to save more for retirement and retire early, unless you are extremely thrifty with your spending, you need to know what your are spending your money on, and how much, in order to put more money towards debt reduction or retirement savings.

Run your household like a business

Companies or businesses can’t exist very long without a budget- Almost all businesses of any size create a business budget to track expenses vs. income throughout the year. They must get deep into the numbers, and be able to show that they are operating within their means to get bank loans or lines of credit to make payroll. Why should your household be any different?

How to set up a personal or household budget

You need to figure out where your money is coming from, and more important and difficult, where it is going.

List all income sources

If you only have a paycheck from a regular job, for you and/or your spouse, this in your total income. If you have other sources like a part-time job or hobby that makes some money, list those as well. If you want to budget with your after tax income, or your take home pay (after insurance deductibles and 401k or retirement contributions), that is OK, or you can include those in your budget if you want. Since that money is not available to me, I use my take home pay, but I think either way is probably fine.

List all expenses

You should be able to rattle off your fixed expenses, like mortgage or rent, car payments, etc., but you may want to average other bills, like electricity or gas, as some of them fluctuate based on the season. You also need to figure out how much you spend on groceries, eating out, and other miscellaneous spending categories. Basically, you need to see where all of your money is going. I find looking at several months to a year of bank statements and credit card bills should suffice.

List all of the categories you have, and get a pretty good number on your total monthly expenses. You need to categorize “unaccounted for” transactions as well, such as ATM withdrawals. If you take out a lot of cash from ATMs regularly, you need to set a limit for that on a regular basis, such as weekly, monthly, or when you get paid, especially if this accounts for a large number in your expenses or expenditures column and you are not sure where it really goes.

If your expenses exceed your income, you obviously need to reduce expenses to below your income.

Once you see where your money is coming from and where it is going, it is up to you to decide where you are spending too much, and try to cut back in those areas-or reduce your budget- in order to free up money for the things you want to use it for, such as debt reduction, etc.

When you look at the numbers, don’t be surprised if you are surprised by where your money actually goes-If you haven’t been sticking to a budget, it is very easy to spend more than you think you are, especially on casual spending. Now that you have examined your expenses and set up a budget, stick to it, and you will find it a lot easier to reach your goals.