A budget is just a written plan of how you plan to spend your money every month, which will allow you to contribute money to savings and retirement.
A good budget will help you live within your means, or even below your means. A budget is a long-term, even permanent activity. You can’t dig yourself out of debt then go back to the old habits that got you in debt.
When you are in debt, a budget is a great plan to help you get out of it. It isn’t rocket science but most people fail at this task because they simply don’t stick to it.
Making a budget and sticking to it
Building and sticking to a budget is like sticking to a diet and exercise plan. Most people have good intentions by starting but then they eventually go back to their old habits and stop together.
If you are in debt $10,000 and you create a budget that allows you to save $250 per month then in 40 months (or 3.33) years, you will pay off the $10,000 debt.
If you think 40 months is too long, then you can look at your budget to determine if there are any additional costs you can cut or reduce. You may realize that if you cut your cable TV off, it will save you $100 per month.
Adding the $100 to the $250, you will be able to save $350 per month and now it will take 28.6 months (or 2.4 years) to pay off the $10,000 debt. If you are still not happy, you can cut other expenses or try to increase your income by finding another job, getting a part-time job, or starting a side business.
The hardest part of a successful budget is “SUSTAINING” it.
You have to stick to it month after month and eventually, you will hit your goals.
- Living on a budget will allow you to:
- Save money, especially for setbacks, such as losing your job.
- Live at or below your means so you can save money.
- Allow you to eventually buy big-ticket items without using credit or taking out loans.
- Measure your performance. If you are not meeting your goals, your budget will make it evident.
Your Current Debt
What is your current debt? Do you know it? Most people don’t even know how much debt they owe. They have an idea, but they have never taken a pen to paper to calculate their true debt.
Additionally, most people don’t know the true cost of their debt. A current credit card balance of $10,000 with a 14% APR will cost hundreds or thousands depending on how long you take to pay it off and with possible fees.
Some of the questions you need to answer to determine the severity of your debt include:
- Do you have enough money to pay your bills every month?
- Do you pay your bills late because you just don’t have the money?
- Do you have no idea how much money you owe?
- Have you stopped paying some of your bills?
- Do you pay only the minimum required by your credit card because you can’t pay more?
- Are your credit cards maxed out?
- Have you had any of your credit cards canceled for non-payment?
- Do you live from paycheck to paycheck?
- Do you have little to no savings in the bank?
- Are debt collectors calling you or are you receiving threatening mail from them?
- Is your debt affecting your marriage and/or your job?
- Are you arguing with your spouse about your debt?
- Are you losing sleep because of your debt?
If you answer yes to most of the questions listed above, you have serious financial problems. The first step in solving most problems is first realizing that you have a problem.
You must face the truth and gain the self-discipline to make sacrifices which will be tough. Don’t despair, most problems have solutions. Now is the time to act.
With the information on this website, you will have a good start to debt reduction. You will know what to do, how to deal with debt collectors, handle your debt, consolidate your debt, and much more.
Track Your Expenses
Comparing Plan vs. Actual
At the end of every month, you have to measure your performance. Did you hit your plan? A budget does no good if you don’t know how you are doing.
You must determine if you hit your spending goals or didn’t hit your spending goal. If you didn’t, you must know why not and make changes accordingly.
You may realize that you underestimated how much money you spend on lunch and decide to start taking your lunch to work. At the end of every month, you must sit down to compare your plan vs. actual spending.
You must act as if you are a company and operate your finances as if you are a business. You must take it seriously and continuously measure your performance. You must look at it as a challenge that you must win.
Cutting Your Expenses
If you have a budget deficit then you have two choices. You can increase your income or cut expenses. For most people increasing their income isn’t easy. It may require getting a new job or promotion. It may require getting a second job or starting a side business.
The second choice you have is to cut expenses. Cutting expenses is typically much easier. This is why many companies lay off people in difficult economic times. It’s much easier to lay off employees than to sell more products/services.
How to cut expenses
Cutting expenses isn’t easy. This can become a problem especially if you have a family. If you decide to eliminate or reduce your cable TV bill, your spouse or children may be upset by this.
However, cutting your debt will call for drastic measures. The old adage, “if you keep doing what you have always done, you’ll get the same result”, holds true for debt reduction. You must cut expenses that will be a sacrifice.
The first thing to do is to look at your budget and determine “NEEDS” vs. “WANTS”. What must you have in order to live, versus, what you want? This is a good first step to start cutting things from your budget.
Choosing the things you really need
You NEED a place to live, thus you NEED to pay your rent or mortgage. You WANT a smartphone, thus eliminating the monthly data plan can be cut.
Even for things you NEED, you may be able to reduce the cost. For example, having an apartment in the middle of the city that costs you $1,500 per month may cost you $1,000 in the suburbs.
You NEED transportation but do you need a $40,000 BMW or would a $20,000 Toyota Camry do you just fine?
Cutting expenses can be temporary. You may decide to eliminate your cable TV for 1 year to save money. You may decide to watch TV via the Internet for free. After the year, you may evaluate to determine if you are in a better financial position to turn the cable TV back on.
Every expense on your budget must be scrutinized to determine if you can cut or eliminate it. You must be tough. You must be determined. You must be strong.
Your ultimate goal is to reduce your debt as much as possible to hit your goals. If your goal is to pay off $10,000 in 24 months which requires you to save an additional $417 per month, then you cut your budget until you can reduce your expenses by $417 per month.
You’ll be surprised that you can accomplish this task. It may seem daunting, but it’s doable.
Threaten Your Company to Reduce Expense
One technique to reduce your expenses is to threaten your telephone, Internet, cell phone, cable/satellite, etc. Tell them you are considering switching to their competitors and 9 times out of 10 they will bend over backward to keep you as a customer.
I’ve used this technique many times to reduce expenses. For example, I was able to reduce my telephone/Internet AT&T bill from about $90/month to $60/month by threatening to switch to their competitor.
Your Current Finances
In order to reduce or better yet, eliminate your debt, you first need to know your current status. You need to go on a fact-finding exercise to determine your money situation.
I’m a strong believer in managing yourself like a business. The main goal of for-profit companies is to maximize earnings for shareholders. How do you do this, you maximize income and reduce expenses to get a maximum amount of positive cash flow.
In assessing the financial health of a company, there are 3 main financial statements that you look at; the Income Statement, Balance Sheet, and Cash Flow Statement. You can’t look at just one of these statements to properly assess the financial health of a company. This can be applied to individuals as well.
The Income Statement is fairly simple. For most individuals, it’s their paycheck and any income from investments, child support, and/or alimony.
The Balance Sheet Statement shows your total assets, minus total debt to determine your equity. Think of a house that is worth $150,000 (asset), minus the $50,000 balance of your mortgage loan (debt), thus giving you $50,000 in equity.
The Cash Flow Statement shows all the money you took in from operations (your paycheck), financing (money you borrowed), and investing (money from your investments), minus the money you paid out.
Of all the financial statements, the cash flow statement is the most important because if it’s positive, your balance sheet will be ok and you are taking in income.
Your Cash Flow
As stated above your cash flow is simply how much money it took in (your income) vs. how much money you paid out (your spending).
To determine your monthly cash flow you and your spouse (if married) will need the following information from the past 12 months:
• Income statements
• Investment statements
• Bank statements
• Credit card statements
• Cash receipts
• Estimated expenses
Some expenses will have to be estimated, especially if you spend cash. If you know you spend approximately $10 per day on lunch and you work 49 weeks per year, then lunch will cost $10 X 5 X 40 = $2,000 per year.
The first thing you need to calculate is your annual income. This is your take-home pay and not your gross income. However, your income may include child support, alimony, or income from investments (stock, bonds, CDs, real estate).
Below is a simple worksheet:
Annual Income Worksheet
Annual Income
Household take-home pay $_______________
Child support income $_______________
Alimony income $_______________
Rental income $_______________
Investment income (CDs, stocks, bonds, mutual funds, etc) $_______________
Other income $_______________
Total Annual Income $_______________
Add up all the income you received during the last 12 months to determine your Total Annual Income.
The second is to calculate your annual expenses. Most people underestimate how much money they spend, especially if they use cash. You’ll be surprised how spending $5 here, $10 there, $1 over there ads up to hundreds or thousands of dollars in a year.
Also, you may have to estimate some expenses if you pay cash. Be honest as possible when determining your expenses. Your expenses include Fixed Expenses and Variable Expenses.
Fixed Expenses are costs that stay the same every month like your mortgage and car payment. Variable Expenses are costs that fluctuate every month, like food and entertainment.
Most people also incur periodic expenses, which may include auto registration and magazine subscriptions.
Below is a simple worksheet:
Annual Expenses Worksheet
Fixed Expenses
Rent $_______________
Mortgage $_______________
Home equity loan $_______________
Condo or homeowners’ association fee $_______________
Car payment $_______________
Other loans $_______________
Homeowner’s insurance $_______________
Renter’s insurance $_______________
Health insurance $_______________
Auto insurance $_______________
Life insurance $_______________
Other insurance $_______________
Childcare $_______________
Dues and fees $_______________
Cable/satellite service $_______________
Internet access $_______________
Child support obligation $_______________
Alimony obligation $_______________
Other fixed expenses $_______________
Total Annual Fixed Expenses $_______________
Variable Expenses
Groceries $_______________
Cigarettes $_______________
Alcohol $_______________
Home gas $_______________
Electric $_______________
Cell phone $_______________
Car Gas $_______________
Public transportation $_______________
Tolls and parking $_______________
Newspapers, books, and magazines $_______________
Allowances $_______________
After-school activities for kids $_______________
Babysitting $_______________
Entertainment $_______________
Restaurant meals $_______________
Personal care products $_______________
Clothing $_______________
Body care (haircuts, manicures, massages) $_______________
Laundry and dry cleaning $_______________
Out-of-pocket medical expenses $_______________
Lawn care $_______________
Home repair and maintenance $_______________
Other $_______________
Total Annual Variable Expenses $_______________
Periodic Expenses
Insurance $_______________
Auto registration and inspection $_______________
Subscriptions $_______________
Charitable donations $_______________
Tuition $_______________
Dues and fees $_______________
Income taxes $_______________
Property taxes $_______________
Other $_______________
Total Annual Periodic Expenses $_______________
Total Annual Expenses $_______________
Total Annual Income $_______________
minus –
Total Annual Expenses $_______________
equals =
Total Cash Flow $_______________
Add up the numbers in each category (Fixed Expenses, Variable Expenses, and Periodic Expenses)
When you are complete, a good check to see if your numbers are correct is to look at how much money you had at the beginning of the year, vs. the end of the year.
This should be easily found in your bank statements. For example, if “Your Bottom Line” = $7,500, that means at the end of the year you should have about $7,500 in extra cash. If your number is far off (i.e., $7,500 vs. $1,500), you need to go back and look at the worksheet to determine if you missed anything.
If your Cash Flow is negative this means you are spending more money than your household income. If you are not paying all your bills or financing your lifestyle with credit cards or cash advances then you may be further behind and your negative cash flow is much larger.
If your Cash Flow is positive you may be in decent shape, however, if it’s positive by a “small” amount, you may need to change in improving it. If your cash flow is positive, but you are only paying the minimum on your credit cards or you have stopped paying some of your bills, you are not in good shape.
Additionally, if you were to lose your job or had to pay for an expensive illness, you could be very close to financial disaster.
Your Balance Sheet
Another financial statement that you can develop to determine your financial status is the Balance Sheet. As stated above, the Balance Sheet shows your total assets, minus total debt to determine your equity. See the worksheet below.
Balance Statement Worksheet
Assets
Savings (A) $_______________
Checking (B) $_______________
Stock (C) $_______________
401K (D) $_______________
IRA (E) $_______________
House (F) $_______________
Auto(s) (G) $_______________
Other (H) $_______________
Total Assets $_______________
Liabilities
House (I) $_______________
Auto (J) $_______________
Credit card, cash advance (K) $_______________
Other liabilities (L) $_______________
Total debt $_______________
Equity
Cash + stocks equity (A+B+C) $_______________
Retirement equity (D+E) $_______________
House equity (F-I) $_______________
Auto equity (G-J) $_______________
Other equity (H-L) $_______________
Total equity $_______________
If your equity is negative, you are broke. This means if you liquidated all your assets, and paid off all your debts, you won’t have enough money because you have more liabilities than assets.
For many people in debt, their credit card debt may make up a big portion of their debt. You can download the above worksheet and enter the numbers to determine your Total equity. If your equity is positive that is good, but is it positive by an amount you are happy with?
If you have positive equity of $1,000, this is terrible especially if you are approaching retirement.
To improve your equity, you must dig yourself out of debt by creating a positive cash flow. In time, the balance sheet will be taken care of.