Budgets have been in the news a lot lately since the partisan battle over the federal budget continually contributes fodder to the media. Where money should be spent and where should costs be reduced? The answer to those two questions is, indeed, at the heart of balancing the budget… any budget, whether it’s for government, your household, or your business.
According to Merriam-Webster, the definition of a budget is: “an amount of money available for spending that is based on a plan for how it will be spent; a plan used to decide the amount of money that can be spent and how it will be spent.” The critical word in the definition is not “money”; it’s “plan.” The adage “If you fail to plan, you plan to fail” never rang truer than when applied to money management.
Creating a Budget
Many people break into a cold sweat or at least shudder at the thought of creating a budget. Some equate budgeting with eliminating the fun and pleasures from life. This is not true at all, and in fact, somewhat the opposite. By understanding your overall financial picture with a budget, you’ll know where and how much you can spend on those things, and you’ll end up enjoying them more.
If you’re struggling month after month in your business, creating a budget will help you see more of the hard-earned dollars fall to the bottom line and generate the return on investment that you’d like to see.
In every scenario, a budget is about learning the facts and taking control.
Most financial experts agree that the first step in creating a budget is to determine where the money is going. That is typically the side of the financial statement that has the greatest variability. How you go about determining your expenses is up for debate. Some gurus insist that you track every single penny you spend for a month, including writing down every cup of coffee, every ATM fee, and every purchase no matter how small. If you are very disciplined, this approach may work. However, for many people, this somewhat draconian approach derails their efforts before they get halfway through the process.
With the automation available through many sources (e.g. your bank and credit card statements), this work may already be done for you. Regardless, no matter how you go about it, you must line item your expenses.
Consider your monthly expenses:
- Mortgage or rent
- Utilities (electric, water, gas, phones, cable)
- Vehicle expenses (gas, maintenance, insurance)
- Health care
- Insurances (life, homeowners, etc.)
- Entertainment, clothing, school supplies
These are the easy and obvious categories. However, you must also create a line item for taxes that are not automatically withheld. Plus you should also be budgeting for your savings accounts (emergency savings, wish list items, tuition, and retirement).
You can be as broad or as detailed about your expenses as you would like; however, the more detailed you can be, the more information you will have to make the best financial decisions for you and your family.
Determining Income and Setting Priorities
Itemize how much money you have coming in: Your paycheck(s), interest and dividends, money from a side business, rents and royalties. Typically, income is far less variable than expenses. In other words, it’s usually easier to eliminate costs (eating out less, not spending as much on clothing) than it is to increase your income (get a second job). In a nutshell, your income less your expenses should equal zero. If you have more left over, great! You’re on your way to building wealth. If the answer is a negative number, you’re on your way to financial trouble.
Once you have a clear picture of your budget, you’ll also have a picture of your actual priorities. Reality about your priorities is reflected in where your money is going. You might say that saving for your kids’ college tuition is a priority, but that’s not true if the tuition account is not growing. You might say that you know retirement saving is critical, but it’s not really your priority if that money is going to this season’s latest wardrobe.
Once you’ve collected all of the facts regarding expenses and income, now you are able to build your plan of how, when, and where to spend. You don’t have to eliminate fun (entertainment, eating out, etc.), but you do need to establish how much you can spend on those line items. You will also have clarity about where money may be wasted and can eliminate or reduce those expenses.
Ensure that savings is part of the plan and think of it as an expenditure. Don’t wait until the end of the month, thinking you’ll save whatever is left over. That answer will always be zero. Establish the amount and funnel that money into the account.
You will get a sense of accomplishment and feel good about your success as you track your budget every month. Whatever gets measured improves. Measuring your financial health should be a priority! There are plenty of automated ways to create and track your budget. Check out www.mint.com, www.quicken.com, www.quickbooks.com, to name a few. Or run a search on online budget tools to learn about even more.
Budgeting for business uses the same principle: revenue (income) less expenses equals profit (or loss). It’s also important to keep in mind the difference between budgeting and forecasting. The former is a quantified expectation and the latter is an estimate of what will be achieved. In other words, the budget is the plan for where the business wants to go; the forecast is an indication of where it is actually going.
In business, budgeting typically occurs annually and takes into account the details of expenses, income, and cash flow. Forecasting occurs monthly or quarterly and considers short-term operational changes (staffing, inventory, sales projections).
Budgeting and forecasting are both critical for business profitability and more complex than personal budgeting. Waddy Accounting Services is always here to help you with this vital aspect of running your business.
Contact us and we’ll be happy to help you with either your personal or business budgeting needs.