What Is a Budget?
A budget is basically an estimation of income and expenses that is made for a specified future time period. It is a financial plan for a particular time period that can significantly contribute to the success of any financial undertaking. They are employed by governments, individuals, and organizations of any income level. Budget can help to set goals, measure outcomes, and plan contingencies.
How to Create a Budget
A budget can help you to have complete control of your finances. It makes it easier for you to save money for your future. Here are a few steps which will guide you in creating a budget:
- Calculate your net income
You must have a clear understanding of your income before creating a budget. You should never consider your net pay as your total income. Your total income is what is left after all deductions, such as tax, contribution to a retirement plan, etc. Having a clear idea of this will help you avoid overspending.
- Monitor your spending
Once you get a clear picture of your total take-home pay, you must understand where it is going. Tracking your expenses will let you decide where you can save. Start by listing your fixed expenses. Fixed expenses include bills such as rent, mortgages, utilities, etc. Next, you must list out variable expenses. These are expenses that vary from one month to another, such as groceries, gas, and entertainment. You can record your expenses manually using a pen and paper, or an app, or an online budgeting spreadsheet.
- Set realistic goals
Make a list containing your short-term and long-term goals. Your short-term goals must be goals set for one to three years. It includes things like setting up an emergency fund, paying back your loan, etc. Long-term goals are set for decades. They are mostly savings for retirement, a child’s education, etc. Setting a proper goal can help you stick to your budget.
- Have a plan
There is always a difference between things you need to have and things you want to have. Consider following the 50/30/20 rule. It is a budgeting technique that splits your net take-home pay into three. According to this rule, 50% of your total income must go for your needs, 30% for your wants, and 20% for your savings. Another rule that helps in budgeting is the 30-day rule. It is a personal finance strategy that can help with impulse purchases. The rule is that you must write down the name of an item you want to purchase, its cost, and the date. For the next 30 days, you are not supposed to buy the item. After 30 days, if you still want to buy the item, you can purchase that. The science behind the rule is that humans are influenced by their environments and circumstances. So, their preferences may change when situations around them change.
- Review your budget regularly
Once you have created your budget, you must review it regularly. This is to make sure that you follow your budget and that you are staying on track. You have to stick to your budget, and for that, you can set spending limits on your credit card, bank account, etc. Life circumstances and financial situation may change. Regularly reviewing your budget lets you adjust your budget to reflect these changes.
What Is the Purpose of a Budget?
The purpose of a budget is to improve your current financial situation by effectively planning and organizing for the future. With an efficient budget plan, you will be able to control your expenses and make savings from your income. Here are some of the purposes of a budget:
- Can have control over your finances:
When you follow an efficient budget, you can have control over your finances. You will know how to handle your income and expenses effectively by setting limits on your spending. This way, a budget can help you in boosting your financial discipline and control unnecessary expenses. Therefore, a budget acts as a tool for monitoring your actual expenses against planned expenses.
- Helps in financial planning:
Whether it be for personal or business use, a budget can help you effectively plan for your future financial needs. By setting up a financial plan for the future, you will have a clear vision of your cash flow and plan accordingly. This can help you avoid any financial pitfalls and achieve financial stability.
- Easily Allocate Resources:
Based on your individual or business priorities, a budget helps you allocate resources efficiently. This can help you ensure your money, time, and manpower are used effectively. With a budget, you can make sure your essential financial needs are met first while avoiding unnecessary expenses. So you will be able to increase your savings significantly. This can help you maintain balance, prevent overspending, and allocate resources to areas that deliver high returns.
Types of Budgets
Household Budgets:
A household budget is a comprehensive budgeting plan for your household over a specific period on a monthly or annual basis. There are four main types of budgeting methods to consider when planning household budgets. They are:
- Percentage Breakout Budget Plan:
This budget plan is done by breaking down your household income into percentages. This method can help you to organize your income by allocating a percentage to your needs, wants, and savings. The 50/30/20 budgeting rule is one of the popular percentage budgeting rules for households. This rule helps you to split your household expenses efficiently. According to this rule, 50% of your after-tax income will go to your must-have requirements, 30% will go to your spending, and 20% will go to your savings. Since you can allocate money for your needs as well as save, this balanced approach can help you boost your financial confidence.
- Envelope or Cash System:
In an envelope or cash system, you can categorize expenses and savings. Then, put your money in separate envelopes allocated for each category. This will be a better option for people who are likely to overspend or who are not comfortable with digital tools.
- Reverse Budgeting:
In the reverse budgeting method, your focus is to prioritize savings and investments before spending on expenses. Save a certain amount of money each month, along with paying your utility bills. This method is also called ‘pay yourself first.’ This is a beneficial method for people who want to expand their savings. The reverse budgeting method is easy to follow as you do not have to create a separate list for each expense you make. All you need to do is set up a savings account or take up a retirement plan and move your funds automatically. The money left can be used for other expenses.
- Zero-based Budget:
In a zero-based budget method, your income minus your expenses should equal to zero. Therefore, every dollar of your income would be allocated to a specific need. With this method, you can start or create a new budget without depending on the previous budget as your base. You will be able to re-evaluate your priorities and budgets with the zero-budgeting method. This method is really helpful in keeping you from spending more than you make.
Corporate Budgets:
A corporate budget is a financial plan for an organization’s revenues and expenditures over a period, usually a fiscal year. Utilizing a corporate budget helps businesses plan for growth and manage expenses efficiently.
- Master Budget:
A master budget provides your business with a comprehensive financial plan for usually one year and is used as the central financing tool. It provides an overview of your business finances and includes budgets for sales, production, purchasing, labor, and overhead expenses. A master budget is usually created by the business’s financial department coordinating with other departments. Through this budgeting method, businesses will be aware of their financial challenges, and they can allocate assets and resources accordingly.
- Operating Budgets:
An operating budget is a part of a master budget, and it shows all operational expenses and incomes expected over a period. This budget deals with the items from the income and expenses statement and focuses on revenues, expenses, and profits. It consists of several budgets, such as sales budget, production budget, merchandise purchase budget, etc. As the operating budget deals mainly with revenue and expenditure, it is considered a short-term budget. This budget helps businesses determine their progress, whether they are on the right track or not, and take necessary actions to control the process.
- Financial Budgets:
A financial budget is also a part of a master budget, and it includes the business’s cash inflow and outflow. A detailed budgeted balance sheet, capital expenditures, and cash budgets are analyzed while creating a financial budget. This budget includes your firm’s expected income, borrowing needs, debt repayments, and investments. It acts as a long-term blueprint for businesses. Usually, small businesses plan financial budgets for 1-2 years and large businesses for 5-7 years.
- Static Budget:
A static budget is an anticipated budget for all revenues and expenses over a specific period in advance. This kind of budget is not affected by factors like changes in production or sales level. It will remain fixed for the duration it covers; that is why a static budget is also called a fixed budget. This is beneficial for businesses to prevent themselves from overspending and guarantees financial controls. Businesses can also balance their incomes and expenses with a static budget.
- Flexible Budget:
A flexible budget, as the name suggests, can change and is affected by factors such as the sales and production levels of businesses. It is more adaptable and is called an expenditure budget. A flexible budget helps a business owner to easily analyze the efficiency of their business by ensuring cash flows or income expenses align with the expectations of the static budget. This budget is very much suitable for the constantly changing business conditions.
Top Budgeting Tools and Resources
Excel Spreadsheets
Excel spreadsheets are a traditional budgeting resource that is commonly used because of their flexibility and familiarity. They offer a tailored platform that tracks income, expenses, and savings. This lets users create unique budgets that are tailored to their specific needs. The formulas and functions on Excel enable users to automate calculations, which makes budgeting a simple task. Users can even use spending sheets based on different categories, set their financial goals, and oversee their progress over time.
Excel sheets help users create visual charts and graphs, which help them visualize their financial condition, find areas for improvement, and adopt suitable strategies. However, excel sheets require manual data entry and regular updates to ensure accuracy. Project Budget, Personal Monthly Budget, Balance Sheet, and Portfolio Tracker are some of the free Excel spreadsheet templates for budgeting.
Envelopes System
Individuals can track and control their spending with the envelope system. These are basically a method to prevent you from spending more money on a particular category. This method suggests you allocate funds into different envelopes for each of your expenses, such as groceries, entertainment, etc. Once an envelope is empty, you are not allowed to refill the envelope or purchase the item until the next budget period. This way, the method prevents you from overspending.
Nowadays envelope apps and tools are available which replicate the traditional system. The modern method allows users to allocate funds to different virtual envelopes and categories. Some apps even offer features like automatic transaction syncing and customizable budgeting templates. GoodBudget, RealBudget, and Pocketguard are some of the popular Envelope-Budgeting Apps.
Financial Planners
Financial planners are valuable budgeting resources that have professional expertise in financial management. They can provide you with a personalized budget and offer investment strategies depending on your financial situation and goals. They can also offer insights on retirement planning, tax optimization, etc.
Financial planner tools can sync with various accounts, such as bank accounts, credit cards, and investment portfolios. This automation helps users to track spending and oversee progress towards financial goals easily. They also offer features like debt payoff calculators and retirement planning tools, which allow users to have insights for improving their financial situation.
Budgeting Apps
Budgeting apps offer several benefits that make managing finances an easy task. It easily syncs with your bank accounts and credit cards and automatically categorizes your transactions. These apps can eliminate manual tracking and can simplify the management of multiple accounts. Moreover, most apps are available on any mobile device, which lets you have instant access to your budget no matter where you are. They also offer real-time updates on your spending. That is, you can have a clear idea of where your money is going.
A budgeting app can act as a financial coach in which you can set reminders when bills are due and alarms when you are about to overspend. Apps allow you to create a personalized budget based on your economic condition, and whenever your financial situation changes, you can easily update your budget. YNAB and Mint are two of the common budgeting apps available today.
In conclusion, budgeting helps people and businesses manage their income and expenses, set realistic goals, and prepare for short- and long-term financial success. Anyone may manage their finances, reduce overspending, and allocate resources by learning budgeting approaches like the 50/30/20 rule, reverse budgeting, and the zero-based budget. Using spreadsheets or budgeting software, developing and analyzing a budget helps enhance financial discipline, stability, and goal-setting.