Chapter 16

Planning a Budget

Why It’s Important

Budgeting techniques help you keep track of where your money goes so that you can make it go further.

Lifestyle Cost

Income is a limited resource Most people want more goods and services

then they can buy with their income Money management is the process of

planning how to get the most from your income.

With planning you can figure out how to use the income you have to buy the things you really want or need

Lifestyle Cost

A budget is a plan for using your income in a way that best meets your wants and needs.

It’s like a road map or guide that you set up and try to follow

A budget includes a record of your expected income, your planned expenses, and your planned savings over a certain period of time.

Lifestyle Cost

You avoid wasting money on things that are not very important to you, because you decide in advance how you will use your income.

A good budget help you set priorities for spending and saving and keeps track of how you are managing your money

Lifestyle Cost

Planning a budget is easier if you divide the process into five steps

The five steps in planning a budget are: Setting your goals Estimating your income Estimating your expenses Planning for savings Balancing and adjusting your budget as needed

Setting Your Goals

As you prepare to set your monetary goals you have to consider several questions

What do I want to accomplish in the next month? The next year? The next five years? Are my goals practical?

It’s useless to set a goal of buying a new computer in one year if your total income of the year is less than the cost of the computer.

Setting Your Goals

A budget should help you decide which goals you can meet with the amount of money you have

Estimate Income

Knowing how much money you have available is an important step in budgeting process

Your income is the actual amount of money you earn or receive during a given time period.

If you get a weekly allowance, that is considered income

Estimate Income

Wages you earn as a stock clerk at a supermarket or tips you get waiting tables are income

Any interest you earn on savings account or money from investments is also part of your income.

Gross Pay

If you have a job, you may remember your surprise when you got your first paycheck.

Your gross pay is the total amount of money you earned for a specific time.

For example, if you worked 20 hours a week at $6.50 an hour, your gross pay is $130 for the week

Net Pay

You don’t get to keep all of your gross pay. Your gross pay is reduced by various

deductions, or amounts that are taken out of your pay before you receive your paycheck.

Deductions include things like taxes, health insurance, retirement, and union dues.

Your net pay, or take-home pay, is your gross pay minus deductions.

Other Income

If your net pay is the only income you have to consider, it’s easy to figure your total income.

If you are budgeting for a family and other members contribute to the total income, include their take home pay in the budget

If part of your income is from tips, don’t overestimate how much you expect to receive in tips.

Taxes

Full-time workers pay several kinds of taxes, which are deducted from their paychecks.

Withholding, or subtracting taxes from a paycheck to be forwarded to the government, may include federal, state, and local income taxes.

In addition the workers contribution to social security and Medicare is withheld

Taxes

Employers are responsible for forwarding the taxes that are withheld to the government.

Workers who do not have taxes withheld from their paychecks must budget for them.

Self-employed persons, for example pay their taxes directly to the government

Estimate Expenses

You have to plan for a variety of expenses Items you have to spend money on such as

food, rent, and clothing are called expenditures.

You must plan for rent, food, transportation, and any unexpected expenses, such as medical visits.

You also have to take into account the rising costs of some expenses, such as gas

Estimate Expenses

If a budget does not include all estimated expenses, real problems might arise.

There are two basic types of expenses you have to consider.

The two basic types of expenses are: Fixed expenses Variable expenses

Fixed Expenses

Fixed expenses are expenses that occur regularly and that are regularly paid.

They include such things as rent, insurance, and car payments

The amount of a fixed expense might change from time to time, but usually stay the same over long periods of time.

You can not reduce or avoid fixed expense without creating problems

Variable Expenses

Variable expenses are expenses that fluctuate from month to month.

They include expenses such as food, long distance phone charges, entertainment, and gifts.

The amount for these expenses usually vary from month to month

A good way to begin estimating your expenses is to look at how much you paid for similar items in the past

Plan for Savings

A budget is not complete without a regular plan for savings

Not only will savings make it possible for you to meet future wants, but they are also a protection

Savings protect you against expenses that you didn’t budget, that are higher than you expected, or that are completely unexpected.

Balance and Adjust the Budget To maintain a personal budget requires

balancing and adjusting the budget The total estimated income for a period

should equal the total estimated expenses. The difference between how much you

planned to spend and how much you actually spent is the budget variance.

Balance and Adjust the Budget If total expenses are greater than total

income, you have to make some changes in the budget

You must either decrease your expenses or increase your income.

A Sample Budget

Let’s follow the steps that a young couple, Michael and Nora Kemals, used to set up a budget.

They want to plan their spending so they can get the most of their money.

They decided to set up a monthly budget and an annual budget

Step 1: Setting Goals

First, they drew up a list of their goals, both short-term and long-term.

They decided which of their wants were most important to them

Setting goals is the first step in developing a spending plan that will meet as many of their goals as possible

Step 2: Estimating Income

Next they need to estimate their income for the year.

They want to know how much money they would have available during the planning period

Michael, a salesperson, earns a gross annual income of $19,000.

Nora is a management trainee and earns $21,500 a year.

Step 2: Estimating Income

Although they earn a total of $40,500, their take-home pay is only about $31,200.

They used that amount in their planning. If the Kemals had an income from

investments or rental properties, they would include this income in their budget.

Step 3: Estimating Expenses

Next, the Kemals estimated their expenses for the planning period

The Kemals kept a record of actual expenses for the past several months

Then they made a list of planned expenses and savings for the year.

The list included their fixed expenses like rent, and variable expenses like food and clothing

Step 4: Planning for Savings

The Kemals’ savings budget reflects their goals.

To begin saving for a vacation, they’re cutting their entertainment expenses.

When they developed their budget, Michael and Nora had to be sure that the total income figure was the same as the total for planned expenses and savings.

Step 5: Balancing and Adjusting the Budget After their budget was prepared, the Kemals

kept records of their actual expenses and organized their expenses into various categories.

They organized their expenses into various categories such as car exp., rent, and entertainment

After they had estimated annual expenses and income, the Kemals developed a monthly budget

Step 5: Balancing and Adjusting the Budget The Kemals divided the yearly figures by 12 to

estimate how to manage their money from one month to the next.

Step 5: Balancing and Adjusting the Budget At the end of the month, the Kemals

compared their monthly totals with their budgeted amounts to see if they were keeping within their budget.

When they compared their monthly budget amounts with their actual expenses, the Kemals found that they spent less than they had budgeted for.

Step 5: Balancing and Adjusting the Budget They spent less on food, utilities, car

expenses, and entertainment On the other hand, they spent more than

budgeted amounts for health care, clothing, and household expenses.

Even with these differences the Kemals, had money left over at the end, which means they where living within their means.

Adjusting the Budget

After looking at their actual expenses, the Kemals decided to make some changes in their budget

They chose to reduce the amount budgeted for food.

They decided not to decrease the other budgeted amounts, since the utilities and car expense may be higher in the future.

Adjusting the Budget

They increased the budget for clothing and household expenses, the two areas in which their expenses were more than the budgeted amounts.

They increased those two amounts by the amount they reduced the food budget.

The Kemals have adjusted their budget according to their needs.

Using a Computer for Budgeting Many people have computer in their homes Several kinds of software programs are

available for setting up and maintaining a household budget

With a computerized budgeting program, you can store your budgeted amounts and enter your expenses as they occur or at the end of the month.

Using a Computer for Budgeting The computer can give you a quick analysis

of total expenses, including amounts that are over and under the budget.

In addition, the computer can help with “what if” situations.

For example, what if Nora Kemal’s income increased by ten percent, or their rent increased by $50 a month?

Using a Computer for Budgeting What if they also wanted to save for a new

computer How much more would they have to cut from

others to be able to buy a computer in one year

By using computers people could quickly see how changes would affect their budget