Financial Lessons: Creating a Budget

Welcome to another edition of Financial Lessons, the week long series where we cover some of the lessons you SHOULD have learned before graduating high school, but didn’t.  So we go on boldly, covering yet another aspect of personal finance that is quite simple, yet usually ignored: making a budget.  Sit down, put your books away, and get ready for more learning!

The Lesson

Settle down, settle down, we need to get started.  Today, we’re going to talk about making a budget.  Don’t worry, it’s not as tough as it sounds, and hopefully, it doesn’t sound all that tough.  First thing I want you to do is to take out a piece of paper and turn it on its side.  Draw a line dividing it in half, and label the left side ‘Income’ and the right side ‘Expenses’.  You should have something that looks like this:

Not too hard yet, right?  Alright, now you need to list your sources of income on the left.  For you as high schoolers, it’s probably pretty easy: just a part time job, perhaps an allowance.  As you get older, your income will become more diverse, and you’ll have to consider investment income, rental property income, and possibly income from a business, as well as income from a salaried position.  You can do the same thing on the right, listing any expenses you have, from the gas you put into your car to the amount you spend going out on dates.  Again, with age will come complexity, and your expenses will increase over time to cover things like insurance, mortgages, and household expenses on top of your current spending.  You should also budget in some amount for saving and investing each month; if you tell yourself that you’ll ‘invest what’s left’, you’ll almost never find yourself with anything left.

I see some of you are already concerned about how to cover non-monthly expenses and income, like Christmas gifts and automobile inspections.  There’s two ways to handle it.  You can include them only for the months where you have them, although this will make your budgets vary from month to month.  Another method, one that strikes me as superior, is to break your large, non-monthly expenses down into smaller, monthly sums.  If you spend $300 on auto insurance once a year, for example, you can budget $25 for it each month.  Put that money into a designated account or otherwise keep it separate from your regular spending money, and you’ll be sure to have enough when those once in a while bills roll around.  (For the unexpected additions to your budget, like bonuses at work or gifts from your family, you can probably avoid including them; they’re unpredictable, and will only skew your budget to make it look like you have more money available than you really do).

Sum up both sides of your budget, and you should have something that looks a bit like this:

budget-table-21Now that you’ve summed both your income and your expenses, it’s time to subtract your expenses from your income.  Take the total on the left, subtract the total on the right, and you’ll see whether your budget is balanced or not.  If you have a positive number, congratulations!  You’re spending less than you earn, and you have some extra you can save, invest, or possibly just spend.  If you came up with a total of zero, less congratulations are in order; you’re riding on the border of going into debt, and one month with greater expenses than you planned could be disastrous.  Let’s just see what sort of number I have…

Uh oh, I’ve got a negative number; I’m spending more each more than I’m earning.  There’s no way I can keep up this pace without going into debt; clearly, I need to make some budget cuts.  If you can’t bring in more income each month (and there’s usually no way to do that, short of working a lot more overtime), you’ll have to find some fat to trim from your spending.

I suggest numbering all your spending based on the priority it has in your life; you can either start with the highest priority as number one and go down from there, or grade everything like we do here at school.  In that case, a four would be anything you absolutely have to have, like food, running water, and medicine,  a three would be something you’re really reluctant to lose, but could give up to keep the fours, a two would be something you want but don’t need, and a one would be something you can happily lose in order to keep your finances sound.  (A zero would be something you wouldn’t even miss, and are surprised you were even bothering to keep paying for it.)  My priorities would look like this:

As you can see, keeping a roof over my head and the power and water flowing range the highest with me.  My car is next on the list, as I need to be able to go to work and get home again, and I also put food as a three.  Not that I can go without eating more than I can without a house, mind you; instead, this shows that I spend a portion of my food budget on restaurants and other expenses I can cut, while still eating regularly.  My rental property and investments come after that; while I want to keep investing, if push comes to shove, I can cut or even eliminate the amount I spend on this expense.  Last on the list is entertainment; while I don’t want to live the life of a miser and have no fun at all, I can cut back on my movie viewing or pay television without seriously hurting my future or my quality of life.  At this point, you should probably try to break down your expenses in more detail to determine how you would rank the different sub expenses in each category, so you can see how much of your food expenses go into eating out, for example.  But that would give us some rather cluttered graphs on the board, so let’s stick with this.

Now comes the tough part: if you are spending more than you earn, or even if you are spending most of what you earn, you need to cut back.  Depending on how much you need to cut, this can either be fairly easily, or diabolically difficult.  If you only need to cut a small portion of your expenses, it can be possible to get your budget back in balance by trimming off some of the things you don’t really need and cutting back on the expense of things you do need.  In the example I created, we could cut the entertainment budget in half, trim about one hundred dollars from the food budget, and possibly decrease the utility charge by cutting back on water and electric usage.  All of these are fairly painless, and give us a budget that looks like this:

You see, it’s not too hard to get into the black.  The problems start to arise if you need to cut down even more; soon you find that you may run out of ones and twos to cut from your budget, and have to seriously consider how whether you can cut down or even eliminate some of the three and four ranked items on your list.  Still, if you value a balanced budget (and you should, if you don’t want to build up debt) you’ll have to be willing to sit down and seriously consider the priorities you have for your money.

Hopefully, this lesson will help you in making up your own budgets.  For homework, work with your parents to make up a budget for your family, and be sure that it balances out.  *The bell rings.*  Have a great day, students!

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