How does budgeting apply to personal finance?
Budgeting is one of the most basic personal finance tasks you can undertake. A surprising number of people have never even given this subject any thought and fewer still have even attempted to prepare one. So I have deciding to write a series of posts on personal finance budgets - what are they, why do you need one and how do you create one?
Today I will answer the questions - what is a budget and how does it apply to your personal finances?
So What Is A Budget?
A budget is generally a plan which is financial in nature and which maps out expected income and expenditure. Governments have budgets as do corporations. Governments need to understand how much expenditure is planned in what area and when the expenditure is due to occur. This then allows the government to plan what income is needed to cover these expenses. They then have the choice of adjusting taxation policies and debt levels in and effort to match expenditure against cash flows. In a similar way, corporations of all sizes will undergo similar activities to ensure continuing operations and profitability.
A personal or household budget is essentially to same as a government or corporate budget except that it is done on a smaller scale and at a micro level. Granted, an individual wont have the same financial resources as a government does, but the principle is the same.
So a budget is all about understanding what your expected income is over a given period and what your planned expenditure is.
Income could be salary or wages from paid employment. It could be interest on a bank deposit, dividends from stock market holdings or some other form of investment income. Income could equally be a government benefit, pension or other allowance. If you are helping your children set up a simple budget, it could just be their pocket money. Income could even be your regular winnings from the blackjack table or at the racetrack (only joking - nobody wins on a regular basis playing blackjack or betting on the races do they?).
Expenditure is anything you spend money on. This will be things like food, fuel, utilities, clothing and medical expenses. It also includes things like credit card payments, mortgage repayments and other debt servicing costs.
The other items that will appear in the outgoing section of your budget will be things like savings and investments. By this I mean the money you want to put aside each month to contribute to savings and investment plans. It's important to include these items in your personal budget so that they are part of your plan. Planning to save money is the first step on the way to saving money.
How Has A Budget To Do With Personal Finance?
A budget is one of the fundamental building blocks of your personal finance plan. It helps you to understand where your money is coming from and where it is going. You will use it to determine how much excess cash flow you have available each month (or maybe even how much shortfall there is). You can then put the excess towards debt reduction strategies to help you get out of debt. Alternatively you can put the excess to work in the stock market, a mutual fund, a real estate investment or any other type investment that will help you to grow your wealth.
And if you budget has a shortfall, you'll be able to identify it then take steps to address it. Maybe that car loan is too expensive. Maybe you need to re-think your personal loan rates. or you may just be living beyond your means.
Your budget doesn't have to be complex - a pencil and paper will do. However I suspect that excel spreadsheet budget planning is probably the most common method. In an upcoming article I will describe the process of actually preparing a budget.
For now, start thinking about where your money comes from and where it's going. Then keep an eye out for my upcoming article on how to prepare a personal finance budget.
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