Establishing A Monthly Budget: Your Financial Action Plan

Creating a budget for you and for your family is not likely to be among your Top-10 favorite things to do on a rainy day!

In fact, most people avoid this crucial step in personal financial planning like a trip to the dentist. Of course, just like when you fail to visit your dentist and you allow small dental problems to become larger ones, failure to regularly examine and make adjustments to your family’s budget will allow small income and spending problems to become quite large and painful, too. Being on a budget, does not necessarily mean being on a strict financial diet. However, sticking to your budget may very well help you to save money and get by on less.

What Exactly is a Monthly Budget?

Most personal or family budgets are figured on a monthly basis. Your monthly budget is yourfinancial action plan. It details the total amount of income you expect to receive during the coming month and exactly what you expect to do with your money during this coming period.

In constructing your own monthly budget, then, you will determine how much of your total household income will be allotted to each of your family’s various “needs” and “wants”. Sticking to this monthly income and spending plan is still the bestway to stay on top of your day-to-day finances and avoid costly money mistakes.

Now, before we proceed with instructions on constructing your own budget, let’s examine some important terms used in budgeting.

Figuring My Income is Simple, Right?

Not necessarily.

Your income, first of all, represents the amount of money you earn in wages. However, in order to construct an accurate monthly budget, you need to consider allsources of income you might receive in addition to your regular paycheck.

Your income may also include child support and alimony, monies received from property ownership (e.g., rental income), sales from home-made crafts or services, a pension or disability benefit, gifts and bonuses you earn, and interest or dividends from investments you have previously made.

In addition, one of the most common errors in personal budgeting is figuring your monthly spending plan based upon grossincome instead ofnetincome. Yourgross incomeis the total value of your wages and monies received from all sources beforeany automatic or voluntary deductions are considered. Automatic deductions are usually taxes such as federal income tax, state, and social security tax. Voluntary deductions are items such as medical and dental insurance fees and contributions to your 401K retirement plan.

Your net income, is your remaining income once all the automatic and voluntary deductions described above have been taken. Your net income, then, is what you actually “pocket” or snare in your personal “net”. Compared with your gross income, (which you can brag about…but, you cannot spend), your net income much more realistically represents, the actual amount of money you have available for your use on a monthly basis. That’s why net income should always be used in determining your monthly budget.

What are Expenses?

These are your monthly obligations. It’s where your money goes. Your expenses are comprised of both necessary and luxury items, that is, things you “need” and things you “want”. Generally speaking, whether they be needs or wants, expenses are of three types:

Fixed expenses occur monthly. They are predictable and remain basically the same each month. Some examples of expenses that are fixed are your mortgage or rent, your insurance premiums, and your loan payments.

Variable expenses also occur monthly but, typically vary up or down in amount. Your food and grocery bill, entertainment expenses, and the money you spend on clothes for you and your family each month are examples of variable expenses.

Finally, incidental expensesare occasional expenses of all different types and amounts. But, just because they are incidental, doesn’t mean that these expenses are necessarily minor. Examples of incidental expenses are repairs to your home or automobile, travel expenses, and the occasional gifts that you purchase for others. While incidental expenses cannot, by their very nature, be predicted precisely, they are inevitable and you will need to anticipate and plan for these expenses if your budget is to remain useful and accurate.

What is a Budget Deficit?

When your expenses exceed your income, your budget will show a deficit and you will be accumulating debt.

When you are in a deficit situation, you may have to borrow the funds you need to cover all your bills and expenses. Almost always, this spells trouble ahead.

Now, in fact, unless you are keeping close track of your income and expenses, you may not even be fully aware of just how severe your budget deficit is until it gets way out of hand.

One reason for this “budgetary blindness” might simply be human nature—that is, all of us tend to deny or ignore uncomfortable situations–like debt– particularly when we don’t feel there is much we can do to change or control these circumstances.

However, you might also be unaware of the severity of your own budget deficit because of the makeshift strategies or ill-advised financial habits you have gotten accustomed to using to try and cover-up your deficit.

For example, when you “juggle” your monthly bills by paying some bills on time and others late, you are actually borrowing funds from yourselfto cover your budget deficit. This may seem like relatively harmless “robbing from Peter to pay Paul”, but it is usually only a short-term solution for your budget deficit and, even worse, it only serves to cover up a growing debt crisis. If you had to go to your bank or to a wealthy family member or friend and ask for a loan each time your spending exceeded your income, you would be painfully aware of your budget deficit situation and would probably act sooner to avoid this situation from happening again.

Credit cards, also, are to blame for why we tend to lose control over our budgets.

Essentially, credit cards are a convenience—a plastic alternative to carrying around cash—and any cards you use should be paid off in fullat the end of each billing cycle.

However, when you carry a balance on any of your credit cards, then you are essentially taking a loan to cover the expenses that exceeded your income (and a usually high interest rate loan at that!). Thus, when you rely upon credit cards, even for purchases you feel are necessities like gasoline and groceries, you are, in fact, covering upinstead of curing your budget deficit. No doubt, you have already painfully become aware that this is a strategy that eventually comes back to haunt you.

What is a Budget Surplus?

When income exceeds expenses, this is called a surplus. However, achieving a budget surplus is actually not the goal of good personal budgeting. A better goal is to achieve a balanced budget, in which the amount of money coming in (income) is equal to the amount of money going out (expenses).

Here’s the problem with a budget surplus. Surplus funds are often mistakenly thought of as discretionary funds because people believe they can use their own discretion and simply choose to use these funds anywaythey like. It’s like “found money”. Most people usually use these surplus funds on a variety of things but, unfortunately cannot tell you precisely on what. (That is where a monthly spending register or log may be beneficial and will be discussed in the next chapter). Typically then, each month’s budget surplus is used up, often with very little to show for it.

Keep in mind, that unless everyexpense that you might possibly encounter is accounted for in your budget and covered by your income, your surplus is not truly surplus. In laying out your expenses, you may not have considered the many incidentals that add up significantly on a daily basis, like routine stops for coffee and snacks, sneakers and shoes for growing children, birthday gifts, and meals eaten at restaurants or taken out. And, what about the unexpected expenses that no one can completely predict or avoid, like sudden car repairs, medical costs, or increases in home utilities.

This is why we recommend, as a cornerstone of solid personal financial planning, that you include “savings” along with all your other monthly expenses in order to more completely balance your budget plan. Indeed, you may wish to have a variety of savings categories that you fund each month and, therefore, list amongst your expenses, such as “emergency savings”(for unanticipated repairs and medical expenses), “holiday shopping account” (for saving throughout the year toward gift purchases), “vacation savings”, “mad-money savings”, etc. When you have, indeed, accounted for all your monthly obligations to others(your bills) and all your obligationsto yourself(your savings), then every dollar coming inand every dollar going out will be accounted for and you will have a completely balanced budget.

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