Budgeting Basics
A budget is at the foundation of any financial plan, but unfortunately, most people don't take the time to create a budget, or have a difficult time following one. While it can be a bit daunting to sit down and go through all of your expenses and find out where you're money is going, that is the only way to completely understand your finances. Without knowing how much money you have coming in and how much is going out, and where it's going, it will be that much harder to get ahead.
Here is a basic introduction to budgeting. Once you learn the basics, you can head over to the step-by-step instructions for creating your own budget. It won't be long and you'll have a better understanding of where you're money goes, and how you can cut back so that you can fund your important financial goals.
Comments
Jeremy,
Your assertion that ‘it can be a bit daunting to sit down and go through all your expenses … ‘ is a classic understatement; and ‘that this is the only way to completely understand your finances’ couldn’t be truer.
A long time ago, I realised that accounting had to be the answer … and so I submit this short article for the benefit of your readers.
What about Personal Accounting?
There are so many articles and blogs today addressing the problems of personal finances, budgeting, debt and provision for retirement, particularly for those living in difficult circumstances such as on a single income, through loss of job, health problems etc.
In regard to any aspect of financial planning, the following are vital:
• knowledge about your personal financial situation
• Ideas on your financial requirements
• your changing ability, over a lifetime, to meet those requirements
• and the particular, changing choices to be made regarding their achievement
Most important perhaps, is the need for basic personal financial management to determine as time goes on, how much is being spent and therefore any surplus available for investment; and the lifestyle changes that might be appropriate if these amounts are deemed insufficient.
Most financial management articles concentrate on investment, loans, insurance etc. Some address potential changes to expenditure via budgets, all with a view to achieving a better overall balance between the increases and decreases. The only problem with this approach, so far as it goes, is that it is always difficult to keep track of the effects of each change and to be aware of how much of a difference each change makes in the bigger picture. The other thing is what is the best balance? How do you know if all the different aspects of financial responsibility are receiving the proper attention they deserve, not only now, but on a continuing, lifetime basis?
The answer surely is a more systematic approach that addresses the fundamentals. What we actually talking about is formally managing and controlling finances – of a particular type – our domestic or personal finances.
We all probably know that in business, the only way, indeed the legally required way, to manage finances is by the use of accounting. Accounting has evolved over hundreds of years with national and international supervisory authorities ensuring that it best meets the needs of the many different forms of business in place throughout the world.
Surely I am not suggesting that we should all start using accounting for managing home finances? Isn’t it much too difficult and time consuming; and help - I do not understand all the terms and techniques!
Well, yes, why not use accounting? I am going to suggest that we do all start to use accounting for managing and controlling our finances, but not quite the sort of accounting that businesses use. The reason is that with appropriate modifications, domestic accounting can be made easy to understand, implement and use. Most important, it can be made to actually produce the real information we need to manage and control our finances, on a continuing basis.
Now well retired, I decided to start using accounting a long time ago to manage my own finances. I had learnt a little about accounting through a business correspondence course and much later, decided to try using it for my personal finances. I bought an off-the-shelf accounting package and set to work. I soon realised that it was all very difficult to do and that it didn’t actually help very much once I got it set-up. The problem was that the focus was all wrong and the reports didn’t relate to day-to-day personal financial transactions.
The business accounting focus, understandably, is all about profits and owner’s or shareholder’s value. The reports such as the Trading account and Profit & Loss account are designed to track and help maximise these values. Most personal accounting packages are based on business accounting with the problems I encountered, or only address simple features (all very useful as far as they go) such as bank statement reconciliation or budget lists.
Over many years, I evolved a new domestic accounting model. By this, I mean the set of reports and individual accounts needed to implement a new form of accounting, with a new focus on what I called, Domestic Well-Being (DWB).
As a model, the method is capable of being implemented on some off-the shelf personal accounting software packages on a home PC. I initially used the well known Microsoft Money© software package but now prefer a package called Personal Accountz©. The differences relate to alternative accounting architectures embodied in these two products – categorisation of transactions versus ‘nominal’ accounts – one account for each increase and decrease category.
DWB Accounting is all about maximising the effect or balance of the decreases compared to the increases, in a way that ensures that appropriate emphasis is given to all of the different categories of each, corresponding to the nature of the financial transactions that characterize domestic life.
What this means is that we have a pre-defined DWB structure for domestic change (the increases and decreases) that goes into successively more detail down this hierarchical structure. From the top level of Basics, Discretionary and Others, the Basics are categorised at the next level in terms of Essentials, Responsibilities and Family Circumstances. Discretionary is sub-categorised as Nice-to-Have, Investment for the Future and Luxuries. At a lower level, Essentials include Utilities, Food and Drink, Clothing, Health and Transport, whilst Nice-to-Have includes Vacation, Leisure and Entertainment, Hobbies, Charities and Timeshare, Mobile home and Caravan, with more and more detail as needed, at successive lower levels.
The model facilitates the bookkeeping which is the means (using individual accounts and/or categories) to enter transactions from bank statements and credit card statements to match the DWB structure; often semi-automated, this typically takes only a couple of hours a month which is trivial compared to the benefits available. Other techniques include naming conventions for the accounts and transactions to make it all easy to understand what is going on, in terms of what I call, the Domestic Accounting Equation.
The main tool or benefit of the model is the Domestic Well-Being Statement (DWBS) which is a structured report showing from high, medium to low sub-category levels, the amounts of increases and decreases over any period – a week, month, quarter, year or whatever. From a management and control perspective, at the top level, you can see the proportions of total expenditure between the Basics, Nice-to-Have and Others. A first question is ‘are these proportions about right’? At a more detailed level, if the Basics are considered too high, you can then see at progressively lower levels in any of the areas, where there might be scope for planned reductions or increases in certain sub-categories, over future periods. It is all about searching for and achieving the best balance across the out-goings!
Of particular interest in this context is Investment for the Future (IFF); are the amounts sufficient and more important if they are not, where is the scope for increasing this amount? Where are the imbalances and which other subcategory amounts are potentially ripe for change?
The key is visibility. Suddenly, everything is exposed. You can see whether appropriate amounts are being put aside for the future; you can see where dangers might be lurking with potential debt problems; and for those with some existing debt, the management of its reduction is much easier to plan and execute.
Budgeting can be set up to plan future expenditure with warnings triggered if spending over the next period approaches pre-set levels in whatever categories or sub-categories are being watched.
For the more adventurous, the model includes new domestic financial ratios for additional control capabilities, as well as numerous graphical displays (a picture speaks a thousand words!).
With a best possible financial balance achieved through maximizing Domestic Well-Being, provision for retirement will be at the fore. Decisions can be made on how best to provide the appropriate amounts for retirement investments and if necessary, change other lifestyle priorities to ensure that the required amounts are made available. Advice will still be needed on the choices and tailoring of investment plans but that is specialised and different from the basic personal financial management required to provide a rock-steady platform for all other financial decisions throughout life.
In the global financial turmoil today, everyone can take advantage of new ideas as a basis for starting to better manage and control their personal finances. DWB Accounting offers the potential for lifestyle improvements and goal achievement since good financial management can point to the need for many other initiatives such as job change, better qualifications, re-location and so on.
In summary, by using accounting for managing and controlling home and personal finances, based on the new Domestic Well-Being accounting model, you will always know in detail, the past and present state of your finances as a proper basis for comparison and control. You will be able to ensure that all aspects of your financial responsibilities are being met through achieving the best possible balance across all of your categories of increases and decreases, based on your own priorities and approach to indebtedness.
All that is demanded is an appropriate sense of responsibility from those in some form of family situation, be it a marriage or partnership, with or without children, or even just a single person. The sooner domestic accounting is underway, the greater the potential for lifetime and continuing benefit. It will take a few months to get things going and to accumulate sufficient figures to start seeing a meaningful basis for gaining and exercising control. Remember that accounting on its own will not get you out of debt or make you rich. It will however enable you to take financial control and to decide what to do but you must exercise the discipline to put your decisions into effect. Now is the time surely, to find out more about DWB Accounting!
John M Passmore