Entrepreneurship University
A Course in Personal Financial Planning

Introduction to Budgeting

Why You Need a Personal Budget

In today’s world there are very few people who take the time to create a personal budget. Some people do not see the value in doing so; other people simply have no desire to restrict their spending habits. With this in mind, it should surprise no one that the number of personal bankruptcies has reached an all time high.

A personal budget is a financial plan which sets limits on the amount of money that will be spent on each category of expenses in a given month. A good budget will take into consideration such factors as: the amount of income being received, outstanding debt to be retired, retirement savings, and an emergency fund.

Many people have no idea exactly where or how they spend a good portion of their money. How many times have you taken money from the ATM only to realize a couple of days later that it is gone? Many times it is difficult to remember how exactly you spent the money, and often times this money is wasted on frivolous purchases. A budget will help prevent this from happening by making a person accountable for the money that they spend. If a person only has $50 left for monthly food expenses then they may decide to forgo purchasing that fancy $3 designer cup of coffee.

Another great benefit is that a budget portrays an accurate idea of how much an individual can actually afford to pay for various consumer items. Whether it’s a house, a car, or a new TV, a person will be able to determine whether or not a certain purchase will fit within their monetary constraints. This acts as a safeguard against getting in over your head financially.

It is important to realize that simply creating a budget is not enough. This in and of itself will do a person absolutely no good if he does not discipline himself to stick to it. At times this will very difficult, particularly if a person has established the habit of freely spending without a second thought. However, the long term benefits of financial freedom, debt free living, and a comfortable retirement far outweigh any potential difficulty.

Creating a Budget

Many people are not fully convinced that they have a need for a budget. Their reasoning goes something like this. “All I need to do is spend less than I make, and that’s just common sense, so why in the world do I need a budget?” If this sounds like something you have said in the past, you probably have a bigger need than you think. Other people fully realize their need, but they simply have no idea where to start. With this in mind let’s walk through the basic steps of creating a personal budget.

Budgetary Steps

  • Create a list of all of your monthly income. If you have any sources of income that are received annually then simply divide this number by 12. It is important to list all sources including alimony, child support, side jobs, etc. This figure will set the cap on your total budget.

  • Create a list of all your monthly expenses. If an expense occurs less frequently, simply prorate it to fit a monthly format. Be sure to include such expenses as; housing, food, transportation, utilities, entertainment, etc. It is wise to track your spending for a full month during this stage of budgetary planning. Save your receipts and each evening write down your expenses for the day. This is the best way to gain an accurate reflection of actual expenses.

  • Determine if your income covers all of your current expenses. If the answer is no, then expenses need to be reduced.

  • Adjust expenses. This can be done in a variety of ways. Depending on the amount of the shortfall, it may be a simple matter of reducing some discretionary spending, such as entertainment, or food, i.e., the number of times you eat out in a given month) If the deficit is larger then it may be a matter of downsizing your vehicle or your living arrangements. If your income covers all of your expenses then this is still a good opportunity to trim some of the fat off of your spending habits. This can help free up extra money for a variety of reasons ranging from, college educations for the kids, to a nice anniversary trip with your wife.

  • Add new categories if necessary. Three areas that are often overlooked are 1) debt reduction 2) retirement savings and 3) emergency savings. An emergency fund will ensure that there is an adequate amount available to cover an unforeseen even (i.e. the car breaks down) should it arise. This will prevent the use of credit which can quickly break a personal budget.

The Advantages of Living on a Budget

The majority of people today are not living on a personal budget. The availability of credit has allowed people to purchase what they want when they want with little regard to whether or not they can actually afford it. There is little hope that people will change these patterns of behavior in favor of living on a budget until they realize the number of corresponding advantages.

A major advantage of living on a budget is that it relieves a great deal of financially related stress. It’s always fun to spend money at the time of purchase but it is not nearly as fun when the bill comes do. When this happens, some people resort to using credit cards to pay of other cards. Other times people pay their bills and then choose to obtain “payday advance loans” to get them through until the next check. Both of these situations cause a viscous cycle of debt and growing interest. A budget can help ensure that an accumulation of debt is prevented and money will be available throughout the entire month.

Another advantage associated with budgeting is that it allows an individual to regularly place money into savings plans. This will allow the person to enjoy a comfortable retirement when that stage of life rolls around. It will also provide a financial cushion to cover any emergency situations that may arise.

Other Budgetary Advantages

  • Goal achievements. Most people have set financial goals that they would like to reach at some point in the future. Sometimes this may be an exotic anniversary trip, or it may be a brand new car or a college education. A budget can help people save money to make these goals a reality.
  • Debt reduction. Many people are being crushed under a heavy load of consumer debt. Without a disciplined pattern of spending it is virtually impossible to make much headway in reducing the debt. A personal budget can provide the framework necessary to begin eliminating these inflated account balances.

One of the great aspects of a personal budget is that it does not offer an “either or solution”. If executed properly a budget will allow a person to simultaneously meet their expenses, place money into savings, and pay back outstanding debt. In view of these advantages, it is truly in all of our best interests to create and implement a personal budget.

5 Pitfalls That Could Destroy Your Budget

With all of the advantages that are associated with living on a personal budget it is no wonder that many people are beginning to implement this system into their own lives. For a great number of individuals the results over time have been nothing short of amazing. People are beginning to work their way out of debt while at the same time meeting their expenses, and placing money into savings. However, it is important to realize that there are potential pitfalls that may be encountered along the way. If people are aware of these hazards then they are far less likely to be negatively affected by them.

  • Credit Cards. These little pieces of plastic can often cause a great deal of temptation and trouble. It is not uncommon for a person to make an unwise purchase, which they would not otherwise make, because they had a credit card handy. The solution to this problem for many people is to get rid of their credit cards and begin paying by cash or check. Some prefer to keep one card for emergency situations but it is best to keep this out of reach, and not in their wallet or purse.

  • Impatience. Problems often arise when people set financial goals but do not have the patience to complete a savings program. For example, let. s say that an individual begins setting money aside for a new car. However, after a couple of months they happen to find a car that they love, and instead of waiting, they go ahead and make the purchase. This could potentially create some serious financially strains. It takes real discipline to prevent impatience from breaking your budget.

  • Lack of adjustments. A budget is created using a set of expenses and income figures that are current at that time. As these figures change it is important that the budget is adjusted to reflect these changes. A failure to do so could lead to some major deficits.

  • Holidays. Unfortunately, many people do not consider holidays at the point that they are creating their budgets. As a result, a proper amount of money has not been set aside for presents, food, etc. These items should be factored in and saved for throughout the entire year.

  • Vacations. Many people accurately factor in the transportation and accommodations, but underestimate the amount of money needed for food and entertainment. Keep in mind that at any kind of “touristy” or resort destination, the prices can easily be 2 to 3 times what you would normally pay at home.