You don’t have to go broke at the end of the month. Or ever. Not when you know how to budget.
In fact, budgeting can help you achieve ALL of your short and long-term goals. No need to cut corners or drop dreams. This discussion will show you how. Budgeting is not complicated at all, especially with us by your side.
A “budget” refers to a detailed spending plan based on income and expenses. Budgeting is one of the most important and basic personal finance steps. Committing a budget to paper and following it is crucial for a healthy financial future. It helps you avoid a financial crisis by estimating how much you will make and are likely to spend over a set time period.
The budget you create will depend on your lifestyle and future financial goals. To create a detailed budget, you need to gather all your financial records and then analyze your current spending.
But there’s more to budgeting than simply creating the plan. That’s only half the job done. Tracking your spending to check whether you are following the plan is a second, extremely important component.
Types of budgeting
There are many budgeting options. Each approach has its advantages and disadvantages. In this segment, we discuss three of the most relevant budgeting methods.
Also referred to as zero-sum budgeting, zero-based budgeting is when you plan to use all your income down to the last rupee. This means creating the budget so that after allocating money for all your expenses, savings, and repayments, you don’t have any balance or money left over. It is a highly detail-oriented budget.
By eliminating the chance of relying on leftover money from previous budgets and the associated false sense of assurance that comes with having that backup money, it encourages you to plan your expenses properly.
You could learn more about this budgeting technique here.
This kind of budgeting is an improved version of the traditional budgeting approach. But the focus here is more on meeting financial goals by analyzing and comparing past performances of the investment and cost-effectiveness.
Performance budgeting uses the past performance data of various investment instruments and strategies for allocating, spending, and managing income. Here, the performance data, including from the past, cost of delivering the output, assessment, and expenditure effectiveness in attaining the objectives are taken on board.
This budgeting method encompasses controlling and planning for any upcoming activities using financial management tools, such as expense tracker, savings goal calculator, etc. It helps you choose the right investment product, control expenses, and find the right funding source or investment mix.
In capital budgeting, one must assess capital, investment benefits, and whether the investment is aligned with the future financial goal. This results in planning the income and expenses associated with other functional areas of your budget and goals.
In other words, capital budgeting is a kind of investment appraisal. You use it to analyze different investments and large expenditures with a view to maximizing your investment yield.
Although it is widely used across enterprises, the capital budgeting method can also be used in personal financial planning.
Why is budgeting important?
We can think of seven reasons that make budgeting important. It helps you with:
- Controlling your daily spending. It does this by exposing bad spending habits.
- Developing a clearly defined process to achieve your financial goals and keeping track of them.
- Prioritizing your financial goals and saving accordingly—to get the maximum value from your investments.
- Avoiding unnecessary debt, which can be financially damaging.
- Preparing for emergencies. From unexpected medical emergencies to home repairs, it helps you cover everything.
- Inculcating financial discipline and building the habit of saving.
- Creating financial stability.
How do I get started on budgeting?
Budgeting can seem complicated to beginners, but it isn’t. Here’s a simple step-by-step guide to help see you through the traditional budgeting process:
Step 1: Making a list of your assets, expenses, and income sources
To begin with, start analyzing your bank statements, investment accounts, and other major expenses incurred over a set period. Calculate the average monthly income, expenses, and savings levels to understand your present financial standing.
Step 2: Setting your goals
Write down all your short and long-term financial goals. For example, the things you want to accomplish in the next six months, the next one year, and the next five years. They need to be factored in as you go along.
Step 3: Calculating your income
The next step includes calculating your available income. First, check the net pay you receive as salary, or otherwise, on a monthly basis. You can also include interest-based income sources if you have any. But, don’t include variable income such as overtime pay, bonuses, or any other variable source of income, as they are uncertain.
Recording your income helps you see how much you can expect to earn each month.
Step 4: Calculating your monthly expenses
You can begin to calculate your monthly expenses by breaking it down into three steps:
- Start by categorizing all your expenses as fixed and variable. Fixed expenses include rent, food expenses, municipal taxes, loan repayments, insurance, and so on. On the other hand, variable expenses include things like costs of entertainment, travel, eating out, or transportation.
- By analyzing your bank statements, credit card statements, store receipts, and any other expenses bills, categorize the expenses incurred in the last six months to one year under the two categories.
- Figure out the average monthly expenses for both categories.
Step 5: Creating your budget
Now that you know your monthly income and expenses, you can start by creating a spending plan. Putting things down on paper is important.
The spending plan should prioritize your needs instead of wants, and resources should be channelized accordingly. You can use the variable and fixed expenses to decide what you’ll spend in the coming months. Consider allocating specific and realistic spending limits for each category.
Also, your expense should not exceed income; it should always be less than or equal to income. In case your expenses exceed this limit, reduce unimportant expenses or simply junk them.
Don’t forget that the goal of budgeting is to maximize savings and reduce expenses. In the long run, even a small sum set aside on a monthly basis can make a big difference.
While planning for savings, the 50:30:20 budget rule may be useful. According to this rule, 50% of the income should be allocated to needs, 30% to wants, and the remaining 20% for savings.
We could all use a little nudge when it comes to saving. Budgeting can help you learn from your past, secure your present, and do even better in the future.
A budget is a piece of paper that helps you confront your mistakes and makes moving in the right direction seem less daunting. We hope our article has also done the same for you.
What do you mean by budgeting?
Budgeting refers to the process of planning and allocating your income and expenses. It involves setting financial goals, tracking your income and spending, and making conscious decisions about how to best utilize your money to meet your needs and priorities.
What is budgeting and its types?
Budgeting is planning income and expenses. Types include zero-based, incremental, fixed, flexible, cash envelope, and 50/30/20 budgets, each with different approaches to allocating and managing finances.
What are the 3 types of budgets?
The three types of budgets are operating budget, capital budget, and cash budget. Operating budgets focus on day-to-day expenses, capital budgets on long-term investments, and cash budgets on cash flow management.
What is budgeting definition importance?
Budgeting is the process of planning and managing your income and expenses. It is important because it helps you track your financial progress, make informed spending decisions, save for goals, avoid debt, and have better control over your financial well-being.
What is the “50/30/20 budget rule”?
The “50/30/20 budget rule” is a guideline for allocating your income. It suggests that 50% of your income should go towards needs, 30% towards wants, and 20% towards savings and debt repayment.