Budget for Success
Start your budget with these 3 easy steps
3 Easy Steps to Budgeting
You will often read the term "cash flows" in your first step to budgeting, this is because it involves managing your cash flows in and out. Tracking down your inflows and outflows is simpler than it sounds, you just need to record your income (in) and expenses (out), and there are several free budgeting tools out there to help you out. The real challenge is finding ways to optimize your cash flows, and sticking with your budget.
Record, Categorize and Forecast
1. Start recording your cash flows
Let's start with how much you bring in net of tax every month. In this case, say you earn $5,000 every month. This is your cash inflow.
For your cash outflow, you have $5000 of expenses including:
- Mortgage/Rental expense
- Medial/Health fees
- Telecommunication (cell phones, landline, internet, cable)
- Bank fees
- Dining out
Since your cash inflow and cash outflow each consist of $5,000, you have a net cash flow of $0. This isn't the worst case I've seen as there are many individuals out there spending more than they can afford (thanks to credit cards), but this isn't exactly great either. The goal is to maximize your net cash flows to allocate more funds to your savings. In this case, you are saving $0 every month - perfect example of someone who is living pay check to pay check.
If you have never budgeted before, chances are you are probably closer to this scenario. Like I mentioned before, transparency is key here - keep recording your cash flows even if it means looking at your excruciating list of regrets. Soon enough, your cash flows will become a primary source of your bragging rights if you carry on with the budgeting process.
2. Categorize your expenses
Having a list of cash outflows (expenses) is a great start, but it would be even better if we start analyzing the characteristics of each items. One way is to group them by needs and wants (discretionary), and you can even further break this down to fixed and variables.
Here's an example of the grouping above:
- Mortgage/Rental expense (fixed)
- Groceries (variables)
- Medial/Health fees (mixed)
- Telecommunication (cell phones, landline, internet, cable - fixed)
- Utilities (fixed)
- Bank fees (fixed)
- Transportation (mixed)
- Dining out (variables)
- Shopping (variables)
- Uber (variables)
- Entertainment (mixed)
This is an important step because it allows you to find out the best approach to optimizing your expenses by looking at their characteristics. Fixed costs are harder to break out of because you will either have it or not - your rental expenses will likely remain the same unless you move out. You will find that some expenses are correlated with others, meaning they will fluctuate as one changes. For instance, if you move closer to your work place in downtown, your rentals may go up but your transportation price will go down drastically, and if you decide to cook at home more often, your groceries will go up at the same time your dining out goes down. In general, variables are easier to control, so they should be the first thing you would look at when it comes to budgeting.
3. Build a "forecast" for your cash flows
Now, before you wrap this up and call it quits, I forgot to mention that you can still maintain a good standard of living and continue doing what you love to do. The whole point of this exercise is to allocate more towards spending that you value the most, while cutting the ones you don't care for. I'm a real foodie, and I spend most of my money on high-end groceries and occasional dine outs. I balance this habit by keeping a tighter budget on other needs and wants like moving closer to workplace with a roommate (negotiating for inclusive utilities), and using company phone for all essential calls while having my secondary phone connected to wifi for social needs. The result is having more than 80% of my cash inflows allocated to my savings.
In order to achieve the same results, it's important to keep a look out on your future spending before they occur. This is the forecasting aspect of the budget, that allows you to build a strong cash flow. Based on your past cash inflow and outflow, speculate on how your cash flows will look like in the current and future months, and encourage yourself to improve your net cash flow on a monthly basis. Every decision that you take throughout your life will change the outcome of your financial goals.