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Budgeting - the Cornerstone of Personal Financial Planning

A budget is simply a profile of how money flows into and out of your life. For most people creating a budget is a painful task; however it is a great instrument to control your finances.

The Importance of Budgeting

Having control over your finances is very important in order to be able to do the things you enjoy and achieve your financial goals. Therefore budgeting should be the first step of your personal financial plan.

No matter how much money you make, you need a budget in order to keep track of your expenses and have a strong sense of how you spend your money. If you are convinced that you know where your money goes without any record keeping system and without monitoring your budget, just make the following experiment:

Spend one month recording every penny you spend. You will be really surprised what the final sum of your seemingly small expenditures will add up to. Categorize your regular expenses and see the results for yourself.

Here is an example:

Habit Price Monthly Cost Yearly Cost
1 cup of coffee every day $2 $60 $720
1 pack of cigarettes every day $2.5 $75 $900
Eating out lunch 5 days a week $5-$10 $150-$300 $1800-$3600
3 chocolate bars a week $3 $36 $432
2 drinks at a bar a week $10-$15 $80-$120 $960-$1440

You didn't realize that your favorite daily cup of coffee may cost you the equivalent of a wide screen TV every year, right? Or that you could save a small fortune if you made your own $2-$4 lunch at home instead of eating out every day. Not to mention the positive impact on your finances if you stop smoking.

Surely, after such calculations you will no longer think of a budget as financial handcuffs and will better understand the importance of budgeting. In fact, it is not an overstatement if we say that budgeting is the cornerstone of personal financial planning and necessity for your financial success.

How to Create a Budget

Basically, a budget consists of two parts - income and expenses. Your objective here is to never let your expenses get bigger than your income.

  1. Start with determining your exact income.

    If you have any outside sources of income, record them too. Estimate your total income as a monthly amount.

  2. List all of your monthly expenses.

    Include both your fixed and variable expenses.

    Consider fixed expenses those that are relatively the same every month and are necessary for your way of living. Here are some examples of fixed monthly expenses:

    • mortgage payment
    • rent
    • car payment
    • cable
    • internet service
    • utilities
    • regular savings (Yes! This is also considered an expense.)
    • etc.

    Variable expenses are those that change from month to month. Here are some examples of variable monthly expenses:

    • personal spending money
    • hair cuts
    • clothes
    • gifts
    • groceries
    • gasoline
    • coffee, cigarettes, soda, etc.
    • entertainment
    • etc.

    List everything you spend money on, even the small purchases.

  3. Add all expenses up.

    Now that you have all of your expenses, add them up. Convert all expenses into monthly expenses. For example, if you pay your property tax once a year, divide the due amount by 12 in order to get the monthly number. You need to get how much money you spend every month as precisely as possible.

  4. Compare your expenses to your income.

    If you have a surplus, good for you! Now reassess your savings in order to make sure you are meeting your financial goals.

    If you have a deficit, it is time to cut back your expenses.

  5. Make adjustments to your expenses.

    Start by figuring out how much exactly you need to trim. Subtract your income from your expenses and you will get the excess expenses number.

    Now, deciding what to cut is the harder part. Here are a few suggestions for reducing your expenses:

    • Stop smoking. (It is good for your health too.)
    • Drop your cable service or at least cut back on the extra subscription channels.
    • Take lunches to work instead of eating out.
    • Rent videos instead of going to the movies.
    • Reduce your utility bills by turning the lights off and turning down the air conditioner when you don't really need them or you are not at home.
    • Shop around for cheaper auto insurance.
    • Talk less on the phone.
  6. Write your budget down and review it every month.

    After the first month is over compare your actual expenses versus those defined by you in your budget. This will help you see where you did well and where you need to make some improvements.

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