Budgeting (Preview of our personal finance course)
Understanding Your Cash Flow
Did you know that the key to successful budgeting is understanding your cash flow? The cash flow statement is a financial document that tracks the money that comes in and goes out of your account.
Example: Consider you have a total income of $5,000 a month. After all expenses are paid, including bills, groceries, and discretionary spending, you have $500 left. Your cash flow statement for the month would show a positive cash flow of $500.
Using the Zero-Based Budgeting Method
The Zero-Based Budgeting (ZBB) method is a strategy where you allocate every dollar of your income to some area of spending or savings, thus giving every dollar a job.
Example: If you earn $4,000 a month, you would distribute all $4,000 across your various categories, such as rent ($1,000), groceries ($300), savings ($500), and so on until you have assigned all $4,000.
Prioritizing with the 50/30/20 Rule
An advanced approach to structuring your budget is using the 50/30/20 rule, which allocates your after-tax income into three buckets: 50% for needs, 30% for wants, and 20% for savings or debt repayment.
Example: earning $3,500 after taxes, you would allocate $1,750 for needs like bills and food, $1,050 for wants like dining out and entertainment, and $700 towards your savings or to pay off debt.
Adjusting the Ratios for Personal Goals
Depending on your personal financial goals, you may adjust the 50/30/20 rule to fit your needs. If you’re aggressively saving for a house, you might switch to a 40/20/40 ratio.
Example: With an after-tax income of $3,500, you could devote $1,400 to needs, $700 to wants, and $1,400 to savings.
Incorporating the Envelope System
The envelope system is a method of budgeting where you use cash for different categories of spending. Each category has an envelope with a specified amount of cash for that period.
Example: If you allocate $600 for groceries each month, you’d put $600 cash in an envelope and only use that cash for grocery expenses for the month.
Combining Envelope System with Digital Tracking
In our digital age, you can combine traditional envelope budgeting with digital tools like budgeting apps that track your spending in real-time.
Example: You might use physical cash for day-to-day expenses but track your bills and regular payments using a budgeting app.
Understanding Sunk Costs
A rare but important concept in budgeting is the idea of sunk costs, which are past expenses that cannot be recovered and should not factor into future budgeting decisions.
Example: If you’ve spent $200 on a gym membership you don’t use, that money is a sunk cost. It should not influence your decision to cancel the membership moving forward.
Using the Debt Snowball Method
The Debt Snowball Method is advanced debt management within your budget where you prioritize paying off debts with the smallest balances first while making minimum payments on larger debts.
Example: You pay off a $500 credit card bill first, before tackling the $2,000 car loan, gaining momentum as each balance is cleared.
Calculating Debt-to-Income Ratio
A crucial calculation for budgeting is your debt-to-income ratio (DTI), which compares your total monthly debt payments to your gross monthly income.
Example: If your monthly debt payments are $1,000 and your monthly gross income is $4,000, your DTI ratio is 25% ($1,000 / $4,000).
Forecasting for Financial Goals
Forecasting involves using estimates to predict future spending and savings. This can help in setting realistic financial goals within your budget.
Example: If you plan to save $6,000 for a vacation over the next year, forecasting that you need to save $500 a month helps you understand how much to budget for this goal.
Utilizing SMART Goals
Ensuring your financial goals are SMART—Specific, Measurable, Achievable, Relevant, and Time-bound—helps make them more attainable within your budget.
Example: Rather than simply wanting to save money, a SMART goal would be aiming to save $1,200 in an emergency fund by the end of six months through setting aside $200 each month.
Related Links from your friends at Your Career Place.
https://yourcareerplace.com/finances/understanding-debt-types/
