In my career as an accountant, we learn about managerial accounting which is used inside company’s and focuses more on budgeting and costs which are reported inside the company instead of externally like the accounting I talked about on the financial accounting page. The reason why I bring this up is there is a way that business plan their budget and it helped me think about personal finance in the most logical way possible.
The first thing that I notice a lot of people do when trying to set a budget is to go from one extreme to another. They go from spending excessive amounts of money to “penny pinching” which don’t work in the long term. That is why the budget must be realistic in the first place or you must have an important goal to reach to stay motivated.
Businesses start their budget planning process by first estimating sales. The logic behind this is that they don’t know how much money they can allocate to other departments without knowing a sales figure which is a way of saying they need to first learn how much money is coming into the business.
On our personal budget, this is our income (money coming in) from our sources of income. My main 3 are royalties, business, and working income. I will do a projection at the begging of the month and set income goals. Personally, I would rather increase my income instead of penny-pinching on ever cent spent. This is a trick I have learned from Bob Proctor who is a motivational speaker and has made many millionaires from his seminars. A quote from his book:
You have to think as hard to increase your business by ten percent as you would to increase it by 50%
I start out with an excel spreadsheet with the income that I am planning on bringing in. This is simply the first section of my spreadsheet for any given month. For some of you, this might be the same amount every month which will make it easy for you to calculate. Simply put your salary or wages you are earning into these income columns.
Another important business term that is often used is fixed expenses. A fixed expense by definition is something that never really changes. These costs will be easy for you to calculate and add from month to month. There is economic proof that a business can survive in the short run as long as they can pay their fixed expenses; however, they would be burning a lot of cash. (using more than they bring in) That is why I like my fixed expenses to stay low in order to survive if I lose an income source for a while. I will make a list of some items that would be characteristic this way.
- Mortgage Payment
- Car Payment
- Insurance Premiums
- Property Taxes
- Anything that has close to the same payment
This is another distinction that a business will make is the variable expenses that they have. The variable expenses are things that change on a monthly basis or change with consumption. You might be thinking that some expenses are semi-variable which means they fit into booth categories. That can be true in the real world. Some examples of these type of expenses would be:
- Transportation (Fuel, Bus Pass, etc)
- Almost anything that isn’t a fixed expense
Once you figure these 3 components out do estimates for how much you will need for the month, pay period or you could do an annual budget. Once you have this part figured out track the budget the best you can over the month. It is hard to get it perfect so do your best.
Create an actual column and add the real expenses to this spreadsheet. After this, I analyze the variances from the budget-actual column. It is important to point out that there can be booth good and bad variances. As an example, one month my business might make more money than I projected which is obviously a good variance; on the other hand, I might have to pay more taxes in the month of April than expected.