What Is a Budget and Why Is it Important?
A budget is a plan you create that outlines how you’ll spend your monthly income. Financial experts emphasize the importance of budgeting for anyone trying to reach financial goals or gain control over spending. If you create a budget and stick to it, you can live within your means and stop worrying about making ends meet each month.
While some people may associate budgeting with restrictions and negativity, creating this monetary plan can be a positive and reassuring task. By setting a budget and sticking with it, you can reach short-term goals — like saving for a fun vacation — or long-term goals, like buying a house. Mapping out your spending isn’t a way to punish yourself or inhibit yourself from having fun. It’s a reliable way to make progress toward your financial goals.
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Purpose of a Budget
The purpose of a budget may differ for everyone, but in most cases, you’ll use this plan to reach specific financial goals. Budgeting can help you achieve some of the following goals.
One of the most common reasons people turn to budgeting is to help them save money. If your financial goal is to save money, you must set a budget that pushes you to live below your means. This way, you have money to contribute to your savings account.
One of the best ways to ensure you reach your goal is to first set the amount of money you want to save each month. Then, transfer this amount directly to your savings account as soon as you get your paycheck. In some cases, you may even be able to set up an automatic withdrawal from your paycheck directly into your savings account. This ensures you set aside this money before you address your monthly expenses.
Control Over Finances
When you build a budget, you choose where you’ll spend your money each month. There are several ways you can decide how your money should be spent. You can look at the transactions you made in the past few months to identify the categories where you need to better manage your money.
You can also use the envelope method to create your personal budget. With this method, you split your spending into categories and give each category a dollar amount. Once that envelope is “empty” and you’ve spent your budget on it, you can no longer contribute money towards that category. For example, say you gave your “dining out” envelope $100 for the month. After two dinners out, your envelope is empty and therefore, you can’t go out to eat again until the next month.
To curb impulse purchases, consider using the 30-day savings rule. This rule requires you to stop before making an impulse purchase and set aside the money into your savings account for 30 days. After the 30 days, if you still want to buy the item, you can take the money from your savings account. In many instances, you’ll decide the item isn’t worth it and that money has helped boost your savings account balance.
Peace of Mind
A budget can be a great source of financial peace of mind. Knowing where your money is being spent and how much you have left for the month can keep you on track with your expenses. By keeping track of your budget, you can also prevent yourself from overspending and you’ll always know where you stand financially.
Becoming Debt Free
Becoming debt-free is another common goal for budgeting. If you’re facing debt and only making the minimum payment each month, it can be hard to reach other financial goals, such as building a savings account or saving up a down payment for a house.
By creating a budget that allows you to pay more towards your debt, you can decrease what you owe quickly. This helps to improve your credit score and makes it easier to save more money each month, which in turn allows you to achieve your long-term financial goals faster.
Personal Budget vs. Business Budget
A personal budget and a business budget are similar in nature. They are both created with the intention of planning how the money will be spent and usually with specific financial goals in mind. However, with a personal budget, you usually have a set amount of monthly income to work with. You can divide this income into the expenses you have and use the extra money to chip away at debt or build your savings account.
If you’re creating a business budget, you may need to work backwards. You must first figure out how much profit your business needs to make each month to cover its expenses before you can create a budget. These monthly expenses will be different than the expenses for a personal budget and may include staff salaries, marketing, or office supplies. As a business owner, your financial goals may include growing the staff or hosting a marketing event. Personal budgeting goals may include paying off a credit card debt or saving for a new car.
Living on a Budget: Tips and Terms to Know
When you’re deciding how to budget your money, don’t look at your plan as restrictive but as a way to improve your financial situation, even if you’re starting off with a minimum wage job. You’ll need to change some bad financial habits but it’s important to remain dedicated to the budget so you can begin to overcome financial hardships. Learning more about budget terminology can help you to better understand the strategies you can use to stay on track.
To maintain a balanced budget, your expenses cannot exceed your income. To ensure the budget you create is balanced, add up the total amount of income you expect each month. Then, add up your necessary expenses. If your expenses are higher than your income, attempt to cut down on these expenses or find a way to increase your income. If you don’t make these changes, you won’t be able to make progress toward your financial goals.
When you’re living on a budget, your financial statements are paramount in helping you to track your progress. You can gain access to your monthly financial statements through your bank, usually by mail or online. Use these statements to review where your money went each month and ask yourself if you stayed on budget. If not, identify where you went wrong and try to improve next month.
When you build your budget, you’ll need to analyze all your monthly expenses. Your debts are often referred to as your financial liabilities and these are fixed expenses. For example, you may have a fixed amount that you must pay each month for your student loans.
Keep in mind that these fixed expenses are different from monthly subscriptions, like a movie streaming service or smartphone music app. If you’re trying to make room in your budget to reach your financial goals, identify the difference between your mandatory financial liabilities and nonessential subscriptions so you can make the necessary cuts.
Wants vs Needs
The purpose of a budget is to prioritize your spending. You’ll need to make some hard spending decisions so you can free up money to contribute toward your goals. Take the time to review your past financial statements so you can see where your money is going. Identify the expenses that you can’t compromise on and the ones you can. This will help you to build a budget you can stick with while still saving money each month.
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This post was updated November 12, 2019. It was originally published October 23, 2019.