If you’re like most people, personal budgeting is very similar to starting a diet. Like a diet, people on a new budget say to themselves “I’m spending too much money, I need to cut back.” But instead of analyzing their prior spending, they usually decide to simply reduce spending on things such as making coffee at home, dining out less frequently, replacing brand names with generics, etc. And like a diet, this works until something unexpected happens, such as a car needing major repairs. Just like that, the well-intentioned “new budget” goes off track.
The question is: how do you build an effective budget for achieving financial goals that you can live with for the long-term? And how do you account for variable (unexpected) expenses?
Your Personal Cash Flow Statement
Before starting a budget, it’s crucial to analyze past expenses, with a simple Cash Flow Statement. You can then project expenses into the future, creating a realistic, manageable budget. First, determine the timeframe of data you want to capture. I recommend a monthly cash flow analysis to start. Determine how much you have in cash reserves. Then document all inflows of cash and total them on an average monthly basis.
- Dividend Income
- Sale of personal property
Then do the same with outflows, such:
- House payment/rent
- Auto payment
- Mobile phone
You will then want to net these, subtracting your expenses from inflows, and get your Closing Monthly Balance, which will be used at the beginning of your next Cash Flow Statement. See my example below to help you get started. It’s important to do this regularly because not all costs happen every month, for example some insurance payments and property taxes happen annually or quarterly.
Building Your Budget
Once your Cash Flow Statement is done, you can start estimating future costs, the budget. Within your budget, fixed expenses are simple, however variable home expenses like electric, gas or oil can throw a wrench in the mix. A good rule of thumb is to average those bills out by season. For example, in winter, Florida electric bills are usually cheaper. Add up all the costs from those months and divide by the number of months, this will create an average.
Your Cash Flow Statement is where you have been, and your Budget is where you are going. A budget is not a static document. It changes and adapts with your life.
Motivation is Key!
The challenge, of course, is creating a realistic budget that you can stick with. This takes focus and diligence about following the plan and spending intelligently. Having the right motivation is a prerequisite. If you’re creating a budget for the first time, remind yourself of the big goals and what you’re trying to accomplish, perhaps it’s saving for retirement or a down payment on a home. Write it down and hang it on your refrigerator or above your desk. Following a budget will eventually become a habit that will be a relief and remove financial stress. No longer will you be saying to yourself “can I afford this?” or feeling worried or guilty about an uncertain purchase.
A good budget is the foundation to any personal financial plan, so get going today!