Budgeting Techniques
Goals:
Key Terms:
Budget Activities – A budget allows you to meet your personal goals with a system of savings and wise spending. By developing a plan for saving and spending income, you will be able to make wise and rewarding personal economic decisions. The main purpose of a budget are to help you do the following:
- Live within your income
- Achieve your financial goals
- Buy wisely
- Avoid credit problems
- Plan for financial emergencies
-Develop good money management skills
Having a written budget is a key part to successful financial management. Your budget may be a simple record of how much you make, how much you plan to spend, and how much you want to save. Or, your budget may be a more detailed record with specific amounts to be spent in categories such as food, clothing, and transportation. A good budget should take very little of your time, but it should provide needed information on spending and savings plans.
The Budget Process – The process of creating a budget involves four main steps.
1. Set financial goals
2. Plan budget categories
3. Maintain financial records
4. Evaluate your budget
Set Financial Goals – Goals identify results you want to achieve. When you can see where you want to go financially, you can develop a budget accordingly.
Writing down short-term and long-term goals will help you decide how to spend and save your money. If your goal is to save money for college, your budget will require more savings. If you are currently working at a job that requires you to spend a lot on transportation, you will have to budget for this item.
Plan Budget Categories – Most financial advisers recommend that an amount be set aside for savings as the first part of a budget. If savings are not considered first, other expenses may use all available income.
After savings, two types of living expenses must be considered. Fixed expenses are costs that occur on a regular basis and are the same amount each time. Examples of fixed expenses include rent, mortgage payments, and insurance premiums.
Variable expenses involve living costs that differ each time and may not be as easy to estimate. These types of expenses include food, clothing, and utilities. Other variable expenses such as medical and dental expenses, may not occur as often and may be large when they do occur.
The amount budgeted for savings and other expenditures is referred to as an allowance. An allowance is the amount of money you plan to use for a certain budget category. Budget categories vary, but eight main divisions are commonly used.
1. Savings – Savings accounts, government bonds, and other investments
2. Food – Food eaten at home and meals eaten away from home
3. Clothing – Clothing, shoes, dry cleaning and repairs
4. Household – Rent, mortgage, property taxes, insurance, utilities, furnishings, household
supplies, painting and repairs
5. Transportation – Auto payments, insurance, operating costs, maintenance, repairs
6. Health and Personal Care – Medical and dental expenses, medications, eye glasses, health
insurance and person car costs
7. Recreation and Education – Books and other reading materials, theater tickets, concerts,
vacations, school expenses, hobbies, club dues
8. Gifts and Contributions – Charitable contributions and personal gifts
How much you set aside for each category will depend on your income, family size, ages of children, cost of living in your area, and work-related expenses. It will also depend on your personal values, needs and goals. A cash flow statement can help you develop budget categories.
Maintain Financial Records – After planning a budget, individuals and families should record their income and expenses to find out if the plan is working. The first line shows the monthly family income (after taxes and other paycheck deductions) and the budget allowances for each category.
During the month, entries for expenditure were recorded. Because the family pays most bills by check, their checkbook is an easy reference for information needed to prepare the income and expense summary.
Evaluate Your Budget – All columns were totaled at the end of the month. Any difference between these amounts is a budget variance.
If actual spending is more than planned spending (such as for the “Household” category) it is referred to as a deficit. When actual spending is less than the budgeted amount (as with “Food” category) a surplus occurs.
A category by category comparison allows you to find areas where changes in the budget may be appropriate. A variance in the actual amount spent and the budgeted amount does not always mean a change in your spending plan is necessary.
Your budgeted amount may still be appropriate with a slight deficit or surplus occurring every few months in some categories. If you expect higher or lower spending in a certain category, a change in your budget is probably needed.
Successful Budgeting – Effective budgeting is an ongoing learning process.
Characteristics of an Effective Budget -
- Must be realistic –it should reflect current income and planned spending
- Should be flexible – when unexpected expenses arise, your spending plan should be able to
adapt for these living costs
- Should be evaluated regularly – every few months, evaluate the budget to determine whether
it is still appropriate
- Must be well-planned and clearly communicated – all family members should discuss financial
goals, wants and needs, and plans for spending
- Should have a simple format – if it is too detailed and difficult to understand, family members
may not be willing to use the spending plan
Types of Budgeting Formats –Most money management software programs have a budgeting feature. They allow you to develop a budget, keep track of your accounts, and pay your bills. They may also aid in financial planning. Many programs can be linked with income tax software so that annual tax forms can be completed more quickly.
Some people believe a checkbook is an effective budgeting system. Be aware that a checking account does not serve the purpose of planning for spending. Your checks are a record of your purchases and paid bills. You still need a plan for using income.
Others keep their budgets in their heads. This system may work for an individual with limited income and few financial commitments. A family with a larger income and more living expenses would find it ineffective. A person with a mental budget also risks forgetting how much is to be spent or has been spent on certain items.
Assignments:
Define Key Terms (Pg. 403)
16-1 Assessment (Pg. 408)
Questions 1-4
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