Managing Money | Budgeting
Although adding and subtracting money is a fairly simple operation, especially with a decimal currency, learning how to budget is more complicated.
Budgeting is the use of planning to ensure that you live within your means and don’t spend more than you can afford.
Budgeting is used both individually and by businesses and other organisations. This page focuses on individual and personal budgeting.
What is Budgeting?
budget, n. a financial statement and programme put before parliament by the Chancellor of the Exchequer, a plan of domestic expenditure or the like.
A budget, then, is a plan of how you are going to spend your money, whether you are the government or an individual. . Budgeting is the process of creating your budget, planning how much money you need to earn or save, and deciding how you will spend it.
Preparing a Personal Monthly Budget
Sensible budgeting has several steps:
1. Work Out Your Income
If you’re employed, receive a pension or benefits and have a regular monthly income, this is relatively easy: it’s your monthly income, less any deductions, taxes, pension payments and the like.
If, as is increasingly the case for many people, you’re self-employed, or you receive an hourly rate depending on how much you work, then this is harder to work out. Probably the best way to do it is to look back at your monthly income over the last six months or so, and take an average. Our page on Averages will help with this.
If you’re a student who receives a termly payment, probably from a student loan, then you need to do your budget on a termly basis, not monthly.
Before you calculate your average income, consider whether any month was atypical for some reason: did you have a holiday, were you ill, or were you paid for a particularly big project? If so, it’s probably best to remove that month from the calculation to avoid biasing the results.
2. Work Out Your Essential Expenditure on Fixed Price Items
This should include any unavoidable fees, bills and loan repayments.
It will probably also include your rent or mortgage payments, council tax, electricity and gas bills, water bills, phone, broadband and other utilities. Also any insurance that is paid monthly, for example, buildings, contents or car insurance.
You will also need to include any annual payments. For example, if you own a car you will need to account for road tax, insurance, service and MOT. All these tend to fall due at the same time, and can be very expensive. It makes sense to divide these annual expenses into 12, and set aside an amount each month to cover the yearly cost.
If you can’t remember the precise amounts, check your bank statements, as these will include any direct debits and regular payments as well as one-off amounts. Do not be tempted to guess.
3. Work Out Your Essential Expenditure on Non-Fixed Price Items
This should include food and groceries, travel and/or commuting expenses, clothes and personal care.
Again,don’t be tempted to guess. You will almost certainly underestimate wildly. Instead, look back at your food and household products bills for the last few months. Although this may not be exact, they should give you a reasonable idea of your average monthly expenditure on food and household items like laundry detergent and other cleaning products.
Make sure you use several months, and also check whether any month was particularly expensive. If so, why? Should you disregard it, or did you stock up on lots of essential items that you only buy every quarter? If that’s the case, you should definitely include that month. If in doubt, make sure your monthly non-fixed expenditure is budgeted as higher than you expect to need.
Additional Expenses for the Self-Employed
If you are self-employed, you should also consider how much you are likely to need to pay in personal income tax and National Insurance Contributions (or equivalent) at the end of the tax year, based on your expected income. This may be difficult to estimate, but you can use one of the many tax calculator apps available to give yourself a likely best- and worst-case figure. Divide the total by twelve and add this amount to your monthly essential expenditure.
You should now know your monthly essential expenditure, including bills, food and any other essentials.
4. Subtract Your Monthly Essential Expenditure from Your Monthly Income
With luck, the answer is positive, because otherwise you need to either earn more money, or spend less than you are already doing, both of which may be difficult to achieve. They are also beyond the scope of this page.
5. Set Aside a Sum for Contingencies
You will have forgotten something from your essential expenditure. This is not only likely, but an immutable law of nature. What’s more, the laws of nature being what they are, you will inevitably discover it during the month that you have to pay for something else unexpected and large, such as the car or some major appliance breaking down.
It is therefore essential to set aside a contingency fund. Realistically, the amount of your contingency fund will need to vary depending on the difference between essential spend and income. But as a general rule, set aside as much as you can afford, and put it into an instant access savings account that pays the best rate of interest that you can find.
Our page on Understanding Savings and Loans provides more information. This may be dull, but it could save you a lot of worry later on.
You may also find it helpful to include in your contingency account monthly contributions to any annual payments such as car insurance or personal income tax bill. Putting them aside into a savings account means that they are earning a little bit of interest, and also that you won’t be tempted to conclude that you have more money than you thought, so you can afford to spend a bit more.
6. Work Out Your Discretionary Spending Amount
Basically, what’s left at the end is what you can spend on other things, whether hobbies, luxuries, entertainment, or a holiday fund. If there’s nothing left, then you have no discretionary spending.
Living Within Your Budget
In many ways, working out your budget plan is the easy part. The difficult part is to stick to it.
To do that, you need to monitor your spending. There are several ways that you can do this.
For example, you can enter everything you spend into an old-fashioned account book. Simple, but effective, because you can see exactly what you spend each month. It also has the advantage that you have to consciously think about every entry, meaning that you are always very aware of every expense; but of course it also has the disadvantage of occasional mistakes in your manual arithmetic.
Alternatively, you could use a spreadsheet, which has the advantage that it will do all the calculations for you. Some banks also provide budgeting tools via their websites, which can be useful, although it may take a bit of work to get them set up and working properly for you. There are also many budgeting and accounting apps available now, which can make the process even easier.
Whichever you choose, you need to keep track of what you spend, and make sure that you’re sticking to your budget.
- Not being tempted to splash out on things that you don’t really need, unless it’s well within your discretionary spend for the month.
- Not being tempted to ‘borrow’ from next month’s discretionary spend. If you can’t afford it right now, don’t buy it, however much of a bargain it may be. This can be a real temptation with credit cards allowing you to postpone spend, but remember that you may need something else even more next month and borrowing money for things that aren't essential can be very expensive and get out of hand quickly. See our page on Savings and Loans for more information.
Living Within a Budget Doesn't Have to be Dull
The idea of budgeting may all sound very dull. However, if you make a point of using part of your discretionary spend to reward yourself for living within your budget, it can be a helpful motivator.
That way your successful budgeting becomes a game, and research shows that we all enjoy the satisfaction of winning. The challenge of playing and winning the game helps to make budgeting feel a little less boring, and that’s got to be a good thing!
Further Reading from Skills You Need
This four-part guide takes you through the basics of numeracy from arithmetic to algebra, with stops in between at fractions, decimals, geometry and statistics.
Whether you want to brush up on your basics, or help your children with their learning, this is the book for you.