Budgeting
A fundamental component of anyone’s Personal Finance is the need to budget their accounts. This applies to businesses, organisations and individuals, and pretty much anyone who makes and spends money.
Budgeting is defined by Investopedia as “an estimation of revenue and expenses over a specified future period of time”; i.e. a financial plan for the future, based on your sources of income and outgoing costs.
Having a budget allows a person to be prepared for the worst outcomes, as well as to live a more stable life – with their expenses controlled and their income well managed.
There are many tools online that you can access in order to plan your budget, but it’s good to have a well-structured idea of how to do it yourself, and where to start.
With a budget, you want to start by looking at your sources of income. By examining how much money you make, from either your salary, your pension, your investments, or any other sources, you can determine how much you can spend. Usually, you will want to be in a surplus. If at the end of the month your expenses surpass your revenue, you will have a negative balance and one of three things could happen:
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You must get into debt (loan, overdraft…);
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You must dip into your savings and affect your future (best case scenario);
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You must ask someone else for money (either as a gift or borrowing).
Neither of these options seem to be desirable to any reasonable adult, as they might make you feel like a burden or irresponsible. Thus, a person must control and manage their money starting off with their income. Typical sources of income include:
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Salary
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Wages
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Social Security benefits and tax credits (although the majority of these were replaced by Universal Credit)
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Occupational and/or private pensions
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Investment Income
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Profit from self-employment
There are others, but we will not mention them. This income should be after paying for taxes, savings, and pension pots. A person should always allocate some percentage of their income into a pension plan and a savings account; what is left subsequently is the net income. After assessing your income, you will want to begin looking at how much money you are spending.
Here, an important distinction must be made between needs and wants. This is crucial for the following reason: needs must absolutely be paid for; wants do not.
Needs remain constant through time, they are stable. You will always need food, shelter and clothing. On the other hand, wants change. You might not always want that brand new car – especially if a new one comes out, or you see a better one after acquiring yours.
A person must always satisfy their needs before their wants. Therefore, in a budget, the needs always come listed first. This is a crucial component of any budget that many people seem to overlook. The only things that you need are:
Food
Home & Utilities
Transport
Mobile Phone & Internet
Clothing
Medicine
Besides these 8 things, which can be technically grouped into 6, there are not many other needs. If a person does not have sufficient financial resources to acquire a car, pay for fuel, maintenance and insurance; then a person should take public transport, get a bicycle, or walk.
Of course, these are basic premises that a person must follow. People have different priorities. Some might opt to live in a 1-bedroom flat, in a less desirable location, and drive a bit of a nicer car. Others will prefer taking public transport and eating lavishly; but needs are, and must always be, the first part of an individual’s expenses.
Afterwards, we list our wants. These can be things such as:
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Holidays
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Designer Clothing
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A new smartphone
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Among others
A person should avoid getting into debt in order to acquire a want. These things are usually superfluous, and most people can live without them. Next week, I will be talking about Holidays and planning for them, so make sure you subscribe for that information!
Lastly, when creating a budget, a person must look at the dates of when money comes in and when money comes out. This is because cashflows can sometimes be negative and sometimes be positive, although the overall balance each year should be positive.
The easiest way to currently structure a Budget is through an electronic spreadsheet. Google Docs now offers a completely free, online interface which is very similar to Microsoft Excel. Click the link below in order to watch a tutorial on it:
https://www.youtube.com/watch?v=FIkZ1sPmKNw
After you have learnt how to work with Google Sheets, here is a free budget spreadsheet file for you to add your own details, saving you the laborious task of creating your own.
Another good idea when creating a budget is to establish beforehand how much you are willing to spend on each need, as a percentage of your total income. For example, you can determine on a £2,000 monthly net income that you need to spend 20% of that on food - £400. Then, you can see that you can afford a rent or mortgage payment at 40% of your income, or £800; with utilities included. Besides this, you will want to have a car, fuel and insurance and that might be another 20% so you spend £400 on all of it together.
Now that you have your needs paid for, you can look at what you want. A holiday might be £600, so you can work out a 10-month payment plan (with interest) somewhere around £650, so £65 per month which is 3.25% of your imaginary net income – alternatively, you can put aside £60 every month and pay for the holiday in January, when it is much cheaper and then you can avoid interest payments. It is for this reason that you should calculate your budget annually. Other things could also be wanted, such as clubbing, dining out, and special gifts and occasions.
One of the best tools to use when doing your budget is the Money Advice Service one:
https://www.moneyadviceservice.org.uk/en/tools/budget-planner
Sometimes, you will find yourself with higher expenses than income. This can lead to a poor financial outcome as debt will be built up and your savings will be gone. Therefore, how can you cut costs to fit your budget? Switching providers on Broadband, Utilities, Insurance and Credit Cards can significantly reduce your costs. The best websites to compare the market for the cheapest quotes are:
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https://www.confused.com/ (mostly insurance quotes)
We will also be looking at methods on saving on the different types of insurance at a later date, when we cover the topic of insurance; make sure you subscribe to us to check that article later!
For travelling, one of the best ways of cutting cost is by acquiring an electric or hybrid car, which has much lower consumption. Another option would be to go fully green, and get a bike, or even taking public transport. Carpooling might be an appropriate option, as well as carpooling with a taxi or an Uber.
Another point to consider is your food bills, which can greatly be reduced if you buy in bulk. Going to CostCo allows you to purchase more food at once and yet saving overall. A different option would be to go to low-cost supermarkets (Lidl and Aldi) or taking advantage of reward cards which give points every time you spend and build a balance that you can use to then reduce your bill annually by £200-400. Also, store-brand products are a great alternative that cut costs immensely!
Besides being able to cut costs down with a budget, you can also plan for future incidents. Just 10 years ago we went through one of the worst financial crises the modern world had ever experienced. This year we are experiencing another economic downturn, with huge income cuts due to the COVID-19 pandemic. The Independent has reported on a study that was made – one in four adults have no savings[1]. Without savings, and a plan that puts money aside, when unexpected events come along you will be doomed.
A person should, in theory, try to save for at least 12 months of outgoing expenses. So, if you have £1,000 monthly outgoing expenses, your safety cushion should be £12,000, always. This can be higher, but this should be your bare minimum safety cushion. It might take a while to build up, but it gives you a lot of peace of mind once it is done.
Creating a budget is an elementary piece of any individual’s personal finance – and we at F.S. Finance highly encourage you to create one. We hope this was helpful and that it gave you sufficient knowledge to get budgeting!