Some call it budget preparation, some call it budget cycle. There’s nothing in the name as long as the process involves four crucial steps.
Keep reading to know what the steps are.
Find out your goals
It’s ironic that the most important part of preparing a budget is often considered the least important. A budget prepared without first figuring out what the budget-maker’s goals are, is bound to fail.
When making a budget, ask yourself how you want to spend your money. Do you prefer saving or are you a free-spending person? As I have mentioned in some of my previous articles, when it comes to finance, the one-size-fits-all approach just doesn’t work.
Why is finding out goals prior to preparing a budget so important? Because how much you’d save at the end of the month and how much you’d spend all through the month would be determined based on that.
If, for example, you have plans of attending a college or starting a business, the budget must either be based entirely around saving or there must be two budgets; one for managing livelihood and the other for accomplishing future goals.
Ever wondered what budget calculation actually means? Money is constantly flowing into your pocket and out of it in the form of earnings and expenses. Accurate calculation means tracking each gain and each expense and using them as insights to understand your present financial standing.
You might want to learn new skills to accurately calculate earnings and expenses in the monthly budget – skills like forensic accounting can help you a lot. Even without such skills, budget calculation is not that hard. Start calculating by separating your gross income from your take home pay. Stock dividends, additional earnings and rental income must be separately listed.
Similar to income, divide monthly expenses into two categories. Under the first category, put all expenses that are necessary. The second category must list the expenses that are not necessary but for fancy purposes like eating out, going to a movie theater, buying an Xbox, etc.
You’d be amazed to see how much insights you can retrieve from your monthly budget just by sorting income and expenses. And mind you these are all actionable insights, as in, you can act upon them. For example, you can use additional income to pay for all the unnecessary expenses.
Be ready to experiment
Most people have a conservative attitude towards budget preparation. They dare to experiment. In my opinion, one shouldn’t be hesitant at all. A little bit of experimentation with your financial life can prove useful in the long run, as long as you are not overdoing it.
Here’s an example; if your monthly expenses and savings are consistent for over a long period of time, say 8 or 10 consecutive months, feel free to introduce a new spending habit or channel some of your savings into the investment portfolio.
Another example; bring changes to how you execute the budget. Do you implement each and everything in the budget exactly the way you drafted it? Do you execute it as quickly as possible? Relax. Be a little carefree next month, indulge in spending habit and see what kind of change that brings to your financial life.
Run a cost-benefit analysis
Ask yourself, is there any point in preparing a budget and keep following it month after month without critically evaluating it? The answer is none. As mentioned in the preceding paragraph, you should feel free to experiment with budgeting every once in a while. But being experimental is the first step.
The final step is to run a cost-benefit analysis. Once you list all the costs and all the benefits, weigh them up. Do the costs outweigh the benefits? If they do, you need to prepare a new budget from scratch. If the benefits far outweigh the costs, it indicates your budgeting method was perfect.
Without a cost-benefit analysis, budgeting is pointless. Imagine your financial life as a boat and the budget your prepare as its sail. The sail helps the boat to move ahead. Similarly, a monthly budget records all your spending and your earnings. When you revisit it on a later date, you realize in which direction your financial life was going back then. A cost-benefit analysis is the tool using which you evaluate the budget.
All the four steps discussed here are important to maintain a balanced financial life. Here’s a bonus tip. Stop worrying too much and stop listening to every advice from everyone. Budgeting methods are a dime a dozen, but not all methods are suitable for everyone. It might take time to figure out which method works best for you. So, don’t be impatient.
No matter what budgeting technique you follow, the four steps detailed here will come in handy. The best part of following these tips is that you get an objective view of your financial life, see things as they are, prepare for the future while at the same time enjoy your present, and most importantly, receive some key insights about your finances.
James Paul is a personal finance blogger at Basic Finance Care which provides valuable insights about personal finance and money management.