What do you think? An individual who is earning more will have better financial future or a person who is earning less but has a systematic budget plan which helps him to save and invest more. You got the answer! Creating a budget is an important step in the process of personal finance management. Having a detailed budget can help you to build your secure financial future with less income and more planning. Let us learn in this article, the basics of creating a budget.
Budget refers to preparing a detailed statement of all the expenses and incomes for a particular period of time. The time period is generally of one month or two. Budget making is an ongoing process which starts from making the statement and ends on reviewing the budget and then back to the first step. This process can be performed by individual households as well as big or small enterprises. Budgeting helps to track the total spending of a month and to eliminate the unnecessary expenses which can be an overhead for the individual.
Benefits of Preparing Budget –
- Financial Control – Budget helps you to keep an eye over all the expenses and gain control over your spendings. This helps you to manage your expenses and control your overspending.
- Resource Planning – Budget making helps you to plan for each and every expense in advance and you can allocate financial resources according to the need of the expense. This will help you to use your resources efficiently and without any financial burden.
- Debt Reduction – Making a budget and creating a plan for all the expenses helps you to save more every month. This money can be used to pay off the debts and release your financial burden.
- Savings growth – When you track your expenses and find out all the possible sources of incomes, you have a better control over your finances which helps you to eliminate unnecessary spendings. This will increase your savings every month and that can be invested to earn better returns.
- Stress Reduction – budgeting will help you to plan the things in advance and keep aside the amount of fixed expenses. In this way, you will be able to pay off all your necessary expenses in the starting of the month only. This will reduce your financial stress as now you will be left out with the money either to be spend or to be saved.
Steps to Create an Effective Budget –
Assess your Financial Situation –
The first and the foremost step in preparing the budget is to analyze all the sources of income. When we will be having a detailed statement of cash inflows, then we will be able to understand our actual financial position. So, for this, list all the possible sources of income –
- Main income sources such as income from full time job or business.
- Income from side hustles such as investments, rental incomes, freelancing etc.
Calculate the net income after doing all the tax deductions. After having the information about the total funds available, next task is to find all the major areas of expenses. It is an important task to find all the possible direct and indirect expenses which will be incurred in the upcoming month. So, for this, list out all the areas of expenses –
- Fixed Expenses – Expenses which will be incurred every month. For example – Rent, utilities, insurance premiums, debt instalments etc.
- Variable Expenses – Expenses which varies according to the need of the time. For example – Groceries, dining out, clothing, entertainment etc.
- Discretionary Expenses – Expenses incurred not for any specific purpose. For example – Subscriptions, hobbies, luxury items etc.
Set Financial Goals –
Financial goals refer to the objectives you want to achieve in a specific time. Each goal must have some specific purpose that need to be fulfilled in a given time period. These specifications help to fulfill your needs and wants in an easy way. This is a major step in budget creation process as it will help to allocate available financial resources in an efficient way and will help to decide the importance of any specific need and want. These goals can be categorized in two types –
- Short term financial goals – Goals which need to be achieved within six months or five years. These objectives are recurring in nature. This includes vacation planning, saving for emergencies and paying off any debt.
- Long term financial goals – Goals that are achievable after five years or more. These are not recurring in nature. Long term goals include planning for retirement or paying off any mortgage loan.
An individual must clearly define all the financial goals and segregate these between short term and long-term categories. During the budget making process, we will allocate the financial resources among all these goals.
Choose a Budgeting Method –
The most important task in preparing a budget is to choose a method which will suit your need. There are various methods available to be chosen from. Each and every method has its own pros and cons. One must decide the budgeting system which best suits his financial situation. There are majorly three types of budgeting methods –
- Zero Based Budgeting – In this method, we will mention all the possible expenses in the starting of the month and allocate all the money to these expenses without leaving a single penny with yourself. Firstly, allocate money to all the important expenses then keep all the remaining amount as your savings. In this way, there will not be any funds left for unnecessary expenses. This method is highly detailed which ensures all the money must be utilized for useful purpose only. On the other hand, it is also a time-consuming task for tracking down all the possible expenses.
- Envelope System – In this method, we distribute funds to each and every category and keep them in the specific envelope. We can only utilize the money for any specific expense available in that envelopes. Once, any envelope gets empty, we cannot spend more for that particular category. If you want to spend more then, it will be possible in the next month. This budgeting method helps to control your over spending and analyze the areas of unnecessary expenses. But it is a cumbersome task for those who are highly dependent on online transactions.
- 50/30/20 rule – This budgeting method creates a percentage-based division of all the funds available. This states that 50% of the income must be utilized for your needs and on major expenses, 30% of the income must be used to satisfy your wants and the rest 20% for savings and debt repayments. This method helps to balance the spendings and savings and is very easy to implement.
Create a Budget –
After analyzing all the possible sources of incomes and expenses and deciding the method to be followed for budgeting, it is now required to clearly prepare a detailed budget report. In this report, all the things will be mentioned according to the method chosen.
Stick to your Budget –
Budget making is not a time bound process; it is a regularly activity which needs to be followed consistently. The major task is to strictly following the budget which we have prepared to have expected results. For this, try to automate your savings and set realistic goals which doesn’t create unnecessary financial burdens.
Monitor and Review your Budget –
This is the most important step in the whole process. Review your budget once in a month to check that the things are going as the way we expected and make necessary changes if required. This activity can be a helpful task so that we can update the budget for the upcoming month to have better results.
By creating a budget, an individual can plan for his wealth generation with lesser income. Budget creation is a continuous process if followed properly, can help you to achieve your financial goals in a short period of time.
