Making Sense of the Budgeting Process
For those who have never budgeted before and aren’t familiar with it, the budgeting process can seem very confusing. It might seem as though budgeting is too difficult to maintain long-term. Fortunately, as you begin to understand it, it does get easier to keep up and follow.
Income Sources
For most people, there will only be a few income sources. They include salary or wages, bonuses, commissions, tips, business income, interest income, dividends, etc. These added together all equal cash inflows.
This is the money you will be spending each month. Don’t look at the total number and think this is all what you get to spend. You will have to save some. If you have a retirement account set up, this will be your inflow after retirement contributions.
Fixed Expenses
Your fixed expenses are all the expenses that don’t change; they are fixed. Every month, these expenses are the same. Over time they may change, but they basically stay the same. They will most often include mortgage or rent, internet access, cable, trash disposal, car payments, phone, etc.
Fixed expenses are the best expenses when it comes to budgeting because they never change. You can always count on them being the same. You don’t have to worry about overspending on them if you allow yourself for them. For example, if you always spend $1,000 on rent every month and you’ve decide you can afford it, you don’t have to change it by downgrading apartments.
Variable Expenses
Variable expenses are tricky. They usually remain the same, but they can vary by $10 or $500. These expenses include cell phone (depending on your usage), water, electricity, food, clothing, entertainment, eating out, gas, small daily expenses such as coffee, etc.
Variable expenses change because prices change and because you may not always be buying the same stuff from month to month. For example, you might spend a lot on groceries one month because you are restocking your cleaning supplies. Another month you may spend less because you don’t have to buy cleaning supplies and you got a lot of good deals.
The best way to deal with variable expenses is to overshoot for them slightly. Keep all the money you allot for food in a folder or account. If you go under, leave the remaining in the account or folder. If you go over, use what you didn’t use in previous months. If you don’t have any from previous months, either cut back on expenses or borrow some from other months.
This can go for most variable expenses, at least the necessary ones like groceries and gas. For extra variable expenses like eating out or entertainment, you should take a different approach. Allow a certain amount each month for entertainment. If you don’t use it all, save the rest for next month. If you run out before the end of the month, stop spending. Find some free entertainment because spending more would be going out of budget.
Emergency Expenses
Sometimes you will have an expense one month that you almost never have. It may be an emergency expense such as a car repair, or it may be unordinary such as renewing your license. You do not necessarily need to allot for this each month. By setting up an emergency fund, you will be ready for these expenses at any time.
An emergency fund should contain at least 3 months but preferably 8 months of living expenses. For example, if your monthly expenses add up to $3,000 a month, you should have at least $9,000 but preferably $24,000 saved in an emergency fund. This will be the money you use in case of any financial emergency including car repairs, medical bills, lay-offs, etc.
To build this fund, you will need to start saving for it each month. Until you have saved enough, all of your savings should go towards it. This does not include retirement contributions and you should pay off all consumer debt first.
For example, let’s say you bring in $5,000 a month after retirement contributions and tax withholdings. This is what you bring in from your checks. Your monthly expenses add up to $3,500. This means you are able to save $1,200 a month. With expense of $3,800 a month, you should build an emergency fund of $28,000. This will take you about 18 months or a year and a half.
For some, building an emergency fund will take only a few weeks, and for others it will take a few years. That’s okay. The important thing is that you have one. Whenever you have an emergency or unordinary expense, take it from your emergency fund. Then, replenish the fund with savings each month until it’s back where it should be.
Savings
As mentioned, after paying off debt, all your savings should first go to an emergency fund. After that, consider increasing your retirement contributions. If you don’t own a home, save for a down-payment. Put aside some savings each month for Christmas gifts or vacation. The more you save the better able you will be to buy the things you really want and will cherish.