What is a budget?
Budget is a careful allocation of your monthly income. Based on a study of your income, present expenses and future plans, a set of spending rules are identified. Then, you spend only according to the pre-decided rules. The idea is to control expenses and make a surplus so that your financial goals are achieved.
How to make a budget?
Budget is vital in keeping your finance in order. Before you begin to create your budget, it is important to list out all your sources of income and expenses separately. Here’s a step by step general guideline to make a good budget.
Step 1. Write down your sources of income
The first step is to write down all your sources of income. Apart from salary or business income do have any other sources like rent or agricultural income? Have fixed deposits? Remember to include all such sources of income.
Step 2. Set aside a sum for income tax.
You cannot start dividing your money straight away. The first and foremost thing to understand is that whatever income you earn, you are liable to pay tax to the government. That’s mandatory everywhere. Some of you may get income only after deduction tax. Depending upon your expected tax liability, you are supposed to set aside an amount to meet the tax commitments.Your tax consultant can tell you how much money you’veto set aside as tax liability.
Step 3. Make a list of fixed commitments.
Once you have computed your total income after tax, the next step is to find out your monthly fixed commitments. Fixed commitments include your monthly rent, school fees for children, EMIs, SIPs etc… These are expenses that stay the same every month and you cannot bring it down by adopting any cost cutting measures. First deduct the total of fixed commitments from the amount you computed in step 2.
Now, what’s the balance left?
For example, you have a monthly income of 50,000 from which you have to pay a tax of 10% which is 5,000. You find that your monthly fixed commitments work out to 28,000. So, 17,000 (45,000 – 28,000) is the balance left with you. This is the amount which is absolutely in your control. You can save it or spend it!
Step 4. Variable commitments
Step 2 minus step 3 gives you a clear idea about how much you can spend on variable expenses. Variable expenses are those on which you have absolute control. Expenses on Items such as entertainment, eating out, gifts etc are variable. It depends on how effectively you control it. It is in this category of expenses that you make all the adjustments.
For example, if you have decided to subscribe for one more Systematic investment plan, you need to cut down and find money from your variable expenses part.
How to track your budget?
Total your monthly income and monthly fixed expense and monthly variable expenses and see if your income is more than your expenses. If yes, you might be doing well ( still, you need to check if something more can be saved from your expenses ). The surplus can be used to pre-pay your loan commitments as soon as possible.
However, If your expenses are higher than income, that’s an alert sign. In this case, you’ll have to control your expenses. If you have some surplus cash left, try to pre-close your loans to the maximum extent possible so that your fixed expenses part can be reduced to that extent. That step may be a bit difficult to do since it involves cash outflow. But, you can definitely control your variable expenses part.
A budget once drawn will not remain fixed for ever. It may have to be re-drawn when your income or fixed expenses part changes.
A Good financial budget planning should include provision for emergency funds. Provision for emergency funds can be set aside as a ‘fixed commitment’ every month because it is very important to have some money in the bank in case you need it for something unexpected such as a medical treatment.
Just in case you had to spend a little more than your budget this month, make sure you cut back your expenses in the following month and compensate for the overspending.
Instead of writing budgets on paper, it will be more convenient to use a spreadsheet like excel where you can easily add or subtract or mike any corrections. Corrections are possible without much fuss and you can also easily plot a variety of different graphs to clearly see things visually.
What are said above are very simple steps. We all do budgeting to a certain extent through mental calculations, although unsystematically. If you are not budgeting you will never know how your income vaporized.