Maxwell is a gainfully employed young professional who by mid-month struggles to cover his expenses for the rest of the month. There are times that his situation gets worse that the monthly bills become almost impossible. Displeased with this regular turn of events, Maxwell discussed his plight with a friend who subsequently discovered that “impulse buying” was one of the reasons why he ends up in this now familiar situation. Simply put, Maxwell spends his income on what he did not plan for. Sadly, this problem is common amongst individuals struggling with how they spend income. A recommended solution is financial budgeting.
A financial budget is a plan that guides the sharing of a person’s total income to their expenses, saving and other uses over a period. By preparing a financial budget, an individual can prioritize expenses based on their income and reduce or eliminate unnecessary spending. A budget also assists in meeting financial goals, and if well tracked, can provide information for improvement.
To help you get started, we will take you through the process of creating, monitoring and evaluating a simple financial budget.
Creating a Financial Budget
First, you identify and document income from all sources. All forms of spending must be recognized and categorized into recurrent or ‘one-time’ and discretionary or non-discretionary spending. Spending is recurrent when it is for things that you need regularly such as food and transportation, whereas it is “one-time” when you spend on things like buying a refrigerator. It is discretionary when you have control over what you are spending, for example, paying for a vacation. The opposite holds for non-discretionary spending like utility charges.
The next step is to obtain the sum of the income, expenses, and find the difference. If the difference is positive (income is greater than expenses), there is a surplus which can either be added to savings or used for other projects. When both are equal (income equals to expenses), the budget is said to be balanced. A negative difference (income is less than expenses) portrays a deficit. This can be corrected either by reducing discretionary spending or increasing income. Usually, it is difficult to boost income within a short period of time, so reducing spending is usually the best option.
There are no fast and hard rules for budgeting, but there is a popular system known as ‘The 50-30-20 Rule”. This is a technique for ensuring a balance between paying bills, achieving financial goals and spending on pleasure. This rule requires that a person’s income should be divided into the three categories accordingly for the budget to be effective. It simply means that an individual should allocate 50% of total income to needs, which include feeding, rent, transportation and other essential items. 30% should be used for wants, which are luxurious things that are not vital for survival such as vacations, fancy accessories etc. Finally, 20% could be invested in financial assets through collective investment schemes.
Monitoring and Evaluating Your Budget
Budgets are prepared ahead of the actual receipt of income and payment of expenses, so it is important to check how these compare with your budget after a period. Because it is difficult to accurately forecast all income and expenses, actual results often deviate from planned figures. So, you should continuously evaluate your budget because it helps you to know the reasons for deviation, creates room for revising assumptions and enables you to make improvements. Also, if your plan changes over time, revise your budget to reflect this.
To evaluate your budget, do these simple things. First, recognize new changes and reflect in your financial goals. For example, if you are getting married or having a child, your financial budget is likely to change drastically. Also, if you are promoted at work and your income increases, it is important to recognize how the additional income will feature in your budget. Second, you should identify the weaknesses of previous budgets and make corrections.
Tools for Preparing a Financial Budget (Evolving Trends in Budget Preparation)
Technology is changing the way things are done and this also applies to a financial budget. There are now applications that have been developed for tracking the flow of income and expenses, and for budgeting. In a world where most transactions are now electronic, these applications are particularly more effective in helping you monitor your budget. The notable ones include Monthly Budget Planner & Daily Expense Tracker, My Budget Book, ‘Spendee’ – Budget and Expense Tracker & Planner, to mention a few. Also, financial budgets can be built using spreadsheets which will allow individuals to automatically see the state of their budget by inputting their income and spending into an already formatted excel document. Templates of this kind are available on the internet and can be downloaded, adopted and adapted for personal use. You may also seek professional help from a financial adviser by responding to this article with your questions.
In summary, a financial budget is needed to have better control over one’s finances and to prevent situations where we are unable to meet our priorities. But ultimately, the discipline to keep to the budget is what ensures that our financial goals are met.
In the words of ‘Joe Biden’; “Don’t tell me what you value, show me your budget and I’ll tell you what you value”. A budget reflects the value a person places on how his/her wealth is spent.
“Budgeting has only one rule, do not go over budget “– Leslie Tayne.
By Fund Managers Association of Nigeria