“I notice that you always stress the importance of budgeting in your columns, but I can never seem to get around to preparing my household budget. It seems like too much effort to work out all those figures. I really need to get my finances under control, but I’m wondering if there is an easier way to do so without going through the process of doing a budget?”

There’s a very simple and straightforward answer to your question: “No.” No matter what your financial concern is; whether it is getting out of debt, investing your money more efficiently, buying a home, or starting your own business, the very first step to getting to your goal is preparing your spending and earning plan – otherwise known as your budget.

Would a contractor start to build on a piece of land without first obtaining a surveyor’s report to understand what was needed to proceed? Would a doctor operate on a patient before she ran the necessary tests to see what the problem was?

In the same way, you have to be very clear about your current financial picture before you can make the desired improvements to your finances.

Why budget?

A budget is more than just some figures written down on a scrap of paper. If it’s done properly, the budget will show you what’s going wrong with your finances, and pinpoint areas for improvement. The budget forces you to take stock of where your money is going every month. If asked, most people do not know the exact amount of money they spend monthly. Many small items add up to large amounts over time and this will be revealed in the budget.

The budget allows you to see your spending figure in conjunction with your earning figure. For many people, when they put their budget on paper, they realize they are spending more than what they earn. This budget deficit is usually financed by credit cards and personal loans. The shortage figure now provides a targeted amount of money by which you need to reduce spending, or the amount by which you should increase your income in order to meet your needs.

How do you prepare a budget plan?

Step 1 – Record compulsory expenses

Write down all your regular monthly expenses- groceries, transportation costs, utilities, rent or mortgage, – all those bills that you must pay every single month.

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Step 2 – Record periodic expenses

Consider those bills that don’t come due every month – cooking gas, car repairs, or school fees. These are expenses that definitely must be paid at some point, but they don’t hit you every month. People usually have trouble meeting their budgets because they don’t plan for these expenses.

Although these bills are not paid monthly, you still need to make a monthly allowance for them in your expense list. To do this, look at the total amount you expect to pay for the entire year for the expense and divide that amount by 12. This
will give you the average monthly cost.

Step 3- Estimate a reasonable amount to spend on non-essentials

Make allowances in your budget for items that you really don’t have to spend on, but you usually end up buying anyway. Clothing, home decorations, entertainment, and gifts are some of those expenses that we tend to spend money on without thinking of them in the overall context of the bigger budget.

We will spend whatever is in our pockets, or worse charge it on the card, without establishing a limit on how much we are really allowed to pay. Work out an amount that you can spend on non-essentials and stick that figure every month. If you didn’t use your budgeted allocation for one month, you can carry forward that figure for future months.

Step 4- Make allowances for emergencies

Look at your past year and see how much you spent on unexpected costs such as home repairs, or medical bills. Divide the total amounts you spent for the year by 12. Then put an average monthly figure in your current budget for these eventualities. If you put aside a little bit each month for life’s emergencies, you won’t be completely taken by surprise.

Step 5- Record all sources of income

After listing all your expenses in categories, the next step is to write down your income sources. If you receive remittances or interest payments in addition to your regular salary, include these amounts.

Step 6 – Subtract expenses from income

Take the total of your monthly expenses from your total income figure, and this will give you a budget shortage or surplus figure. If you’re in negative (as most of us are) this is your target amount to reduce spending or increase earnings. If you are lucky enough to have a surplus, don’t spend it! Invest it instead towards your future financial goals.

Copyright © 2007 Cherryl Hanson Simpson. No reproduction without written consent.

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Originally published in The Daily Observer, June 28, 2007

Cherryl is a financial columnist, consultant and coach. See more of her work at www.financiallyfreenetwork.com and www.financiallysmartonline.com. Contact Cherryl