Developing Your Budget
Deciding how to manage your financial problems requires establishing a budget based on your expected income and expenses. An effective budget will help you identify your options and determine available income for managing outstanding debts. A budget will provide a detailed summary to predict future expenses and determine which expenses are likely to increase.
As you begin budgeting and making the important decisions to reduce your spending, you may find yourself cutting expenses such as entertainment or transportation costs to a minimum—only to find yourself frustrated after a few months of budgeting. Of course, this approach is not recommended. Unrealistic budgeting or making excessive cuts will lead to a sense of hopelessness and frustration. Your goal is success, so be realistic. Try out your options for a month and determine how much your expenses can be cut. Then set your spending limits accordingly.
Trinity provides an informative budgeting workbook with detailed worksheets to help you categorize your expenses. Please call if you would like to learn more about budgeting or to speak with a Trinity credit counselor. Request It’s Not What You Make, It’s How You Spend at (800) 364-1086, or download a copy at trinitycredit.org.
Sticking to a few basic concepts helps to avoid several common pitfalls of budgeting.
Purpose: A budget should have a purpose or defined goal that is achieved within a certain time period. Knowing the source and amount of income and the amounts allocated to expense events are as important as when those cash flow events occur.
Simplicity: The more complicated the budgeting process is, the less likely a person is to keep up with it. The purpose of a personal budget is to identify where income and expenditure is present in the common household; it is not to identify each individual purchase ahead of time. How simplicity is defined with regards to the use of budgeting categories varies from family to family, but many small purchases can generally be lumped into one category.
Flexibility: The budgeting process is designed to be flexible; the consumer should have an expectation that a budget will change from month to month, and will require monthly review. Cost overruns in one category of a budget should in the next month be accounted for or prevented. For example, if a family spends $40 more than they planned on food in spite of their best efforts, next month’s budget should reflect an approximate $40 increase and corresponding decrease in other parts of the budget.
“Busting the budget” is a common pitfall in personal budgeting; frequently busting the budget can allow consumers to fall into pre-budgeting spending habits. Anticipating budget-busting events (and underspending in other categories), and modifying the budget accordingly, allows consumers a level of flexibility with their incomes and expenses.
Budgeting for irregular income
Special precautions need to be taken for families operating on an irregular income. Households with an irregular income should keep two common major pitfalls in mind when planning their finances: spending more than their average income, and running out of money even when income is on average.
Clearly, a household’s need to estimate their average (yearly) income is paramount; spending, which will be relatively constant, needs to be maintained below that amount. A budget being an approximate estimation, room for error should always be allowed so keeping expenses 5% or 10% below the estimated income is a prudent approach. When done correctly, households should end any given year with about 5% of their income left over. Of course, the better the estimates, the better the results will be.
To avoid running out of money because expenses occur before the money actually arrives (known as a cash flow problem in business jargon) a “safety cushion” of excess cash (to cover those months when actual income is below estimations) should be established. There is no easy way to develop a safety cushion, so families frequently have to spend less than they earn until they have accumulated a cushion. This can be a challenging task particularly when starting during a low spot in the earning cycle, although this is how most budgets begin. In general, households that start out with expenses that are 5% or 10% below their average income should slowly develop a cushion of savings that can be accessed when earnings are below average. Whether this rate of building a cushion is fast enough for a given financial situation depends on how variable income is, and whether the budgeting process starts at a high or low point during the earnings cycle.