Thursday, June 28, 2007

The Basics of a Budget

I think that a budget is one of the most basic and useful skills in managing your personal finances. It is a great planning tool.

Basically, you prepare two sections, with four columns each. For the heading of each column, you have "Description", "Amount", "Frequency", and "Period". For now, we will only fill in the first three columns for each section.

The first section is for income. It is the easiest one to fill. You write down all the amounts you expect to receive for the next year. This can be from your salary, dividend payments, whatever. For each amount, write down the frequency (for example, if your salary is a net $800 a week, while you receive $50 in dividends every quarter, write these down). If your income varies with time (for example, if you receive commission income that changes every week), use an average.

The second section is for expenses. That list can be quite long -- grocery, rent, car payments, phone, internet, insurance, clothes. Try to list everything, and include the frequency along with each amount. One good way to structure the expenses section is to use broad categories. For example, this could be:
  • Home (rent or mortage, electricity, heating, taxes, insurance)
  • Transportation (car payment, gas, bus tickets, driving license)
  • Living expenses (grocery, phone, clothes, internet)
  • Leisure (cinema, eating out, books)
  • Others (student loan payment, life insurance, yearly credit card fees)

Once you've written down all the income and expenses you can think of, along with the frequency for each, it's time to bring them down to the same period of time. This can be a week, a pay period, or a month. Use whichever one is most convenient for you.

Now, for each item on your budget, calculate the amount of each item for one period of time. That's what the "Period" column is for. So, if your period of one month, your salary is $800 a week, and you receive quarterly dividends of $50, you would put down $3400 and $16.66, respectively (since a year has 52 week, each month is actually 4.25 weeks).

Calculate the total of the "Period" column for each section. Compare them. Are you spending more than you make? Even if you don't, there should be a margin of safety between your income and your expenses -- after all, we always forget to include something in the list of expenses.

More on budgets next time!

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