If you’re new to the Business Life series in this blog, start here and work your way through the posts before reading this one. Now that you’re actually ready to implement your strategy, you need a way of tracking your performance, this is where budgets really come into play.
Now I know what you’re thinking, budgets are boring AF. I feel your pain, trust me, I have to deal with these at home AND at work. As much I don’t like writing about boring things, this one is too important to ignore.
There probably isn’t a single public company on the planet that doesn’t follow a budget, and the vast majority of smaller companies employ them into their financial plans religiously. Budgets and forecasts are the cornerstones of financial planning the world over, yet, according to a 2013 Gallup survey, just 32% of Americans prepared a monthly budget. Why is there such a disparity between business and people? Why do 100% of large, successful companies use budgets, yet only 32% of Americans do?
Budgets Are Integral for Decision Making
As an accountant, my performance is largely measured in relation to meeting or bettering a budget. I spend large amounts of time developing an annual and monthly budget at the end of each year, before meeting with executive management to discuss it, then presenting the budget to the board of directors for approval. It’s a very formal, very in-depth approach that is taken quite seriously. Throughout the year, every month I sit down with management and compare our actual financial performance with the budget that was agreed upon. We discuss variances to the budget, why one expense might be abnormally high and another abnormally low. We look at how we can improve if we need to and why we are doing better than expected in other areas. This is again presented to the board of directors, who in turn question the financial performance against this bloody budget. Honestly, you would think I am sick to death of these things by the time I get home from work.
Why Budgets Are So Important
I don’t hate budgets in actuality, in fact, I spend nearly as much time preparing our own family budget as I do at work. Each month I look at our actual expenses and income, compare it to the budget and look at areas for improvement if need be. But the question remains, why are these things so damned important? Well, here’s a few reasons:
- Knowledge – The biggest benefit for me is simply knowledge. Just knowing where your money is coming and going is the most important first step in your financial journey. This gives you the power to manipulate your spending in a way that suits your lifestyle, whilst still allowing you to reach your long-term goals. Budgeting doesn’t mean reducing your spending to the bare minimum!
- Control – By knowing where your money is coming and going, you’ll never feel unsure about whether you can afford to do something again. A quick look at your budget and you’ll know if spending that $40 on a night out is going to mean you can’t eat for the next three days. Essentially, it guarantees you are living with your means
- Focus – Many people set long-term, vague goals in their head without ever actually setting time aside to focus on them. Budgeting allows you to break down long-term goals into small, achievable goals that are simple to focus on. Think of it like a weight loss program, for your spending.
- Organisation – Breaking down your spending into categories allows you to see where your money is going and make adjustments along the way. It’s far easier to make incremental adjustments when spending is categorized in this way.
- Goal Setting – Financial freedom is an enormous long-term goal. Breaking this down into monthly goals makes things far less overwhelming. Knowing that you will reach your ultimate 20-year goal by consistently hitting your monthly targets simplifies the whole process. This is where a strategy map comes in handy.
- Preparation – Budgets allow you to plan for large one-off costs, expected or unexpected, by ensuring you have the money available in your bank when you need it.
- Communication & Accountability – Budgeting puts you and your partner on the same page when it comes to financial planning. When you set joint goals and monitor them frequently, budgeting motivates you both to reach them. Looking back at prior month’s spending and seeing where you blew a load of money on crap makes you feel guilty!
- Reduce Stress – Knowing you are financially stable every month is a wonderful feeling. Never having to stress about money could be a huge weight off your shoulders.
Now then, clearly I’m a bit of a budget zealot if I’m being honest, and I live by them fairly religiously. That being said, I understand there are some people out there who get by just fine without budgeting, even many financial freedom bloggers refuse to budget because they don’t think they need to.
To that I say, be veeeeery careful. Some people, for example Mr. Money. Mustache, are hardwired to keep their spending to the absolute minimum. They don’t get tempted by consumerism or luxuries, spending money physically hurts them, they naturally spend very little and generally wouldn’t benefit a great deal from budgeting as their spending is already under extreme control without needing to put in any effort. They also won’t fall off the bandwagon because this is just how they are.
I consider this a unique person. Nearly everybody is tempted to splurge from time to time and, if you’re anything like me (habitual), one splurge might lead to the next, then the next, and the next, before you turn around and realize you don’t quite have that spending under control after all, and you’ve spent a ton of money on small things throughout the month that add up to big things.
At the very least, everybody should be tracking their spending. It’s imperative you are at least equipped with the knowledge of where you are spending your money before you come to the conclusion that you have it under control. Tracking your money at least lets you compare your spending year to year, even if you don’t use this information for setting goals, planning, analyzing etc.
I strongly, strongly encourage budgeting, let’s make that abundantly clear.
Back to the Believers
Okay, now I’ve addressed you budget sceptics it’s time to turn my attention to actual budgeting. There are a few online tools for budgeting that have a bit of a cult following in the personal finance world. I used to be a huge fan of Mint for my budgeting and stuck with them for around 2 years until I was introduced to YNAB. A devastating battle ensued between these two for a couple of months, until YNAB was declared victorious and I deleted my Mint account.
Why I Prefer YNAB Over Mint
I liked Mint initially because it is free, it automatically downloads your transactions, allocates them to spending accounts and generally, it was very user-friendly and simple. The major problem I had with Mint was an inability to set goals, which for me is one of the most important parts about budgeting.
YNAB, on the other hand, is not free. It costs $50 per year, does everything Mint does, but it comes packed with features and a very, very tight-knit community. It’s a super friendly place to do budgeting for newbies, with all sorts of guides, forums and whatnot for helping you with the process. It also allows you to set goals on your journey and track your success in meeting them. You might be a little confused when you begin as they budget like nobody else, but it works really well and makes sense once you’ve got the gist of it.
Where to Begin?
I’m not going to write some long guide about budgeting as it would be boring as hell and there are much better guides out there than I could ever write. All I will say is to start by just tracking your spending for a few months. Create a load of categories (more the merrier) and allocate all spending to them. You might be surprised to see how much you are spending in certain areas of your life, I know I was when I first did this.
After the shock of your embarrassing spending has subsided, start setting goals for categories and controlling it a bit better. This might mean reducing some budgets or shifting spending from one category to another, and that’s all good.
Eventually, you need to decide what savings rate you are aiming for in order to reach financial freedom. This might only be achievable by reducing spending, which obviously budgeting comes in useful for. Once you know the amount you need to save, use your budget to create spending goals that ensure you are not spending too much.
For example, if you want a savings rate of 50% and your take-home pay is $5,000 per month, your budget needs to be $2,500 of spending. Break that up however you like amongst your categories. As long as you don’t go over in any categories, you’re on target. You might come to realize your savings rate goal was too easy or difficult, at which point you can adjust your budget a bit.
The Garden of Eden
Budgeting is a marathon, and eventually, you will reach a stage where you’ve altered your spending in all categories to a level you are happy with, and budgeting simply becomes monitoring to ensure you aren’t stepping over any lines. Eventually, it gets super easy and comes naturally, with minimal effort along the way. Nowadays I like to just check in and see that our spending is in line with our goals. Since I know our short-term goals will allow us to reach financial freedom at the date we want to, I don’t sweat it too much. Could we cut our spending further? Sure, but we don’t really need to. As long as we don’t start spending more as our income rises (and as long as we don’t lose income), our savings rate will only go up, which will only bring our retirement closer.
The Bottom Line
All in all, budgeting has brought a level of calmness to our financial journey. We don’t stress about spending, ever. We know we can maintain our current level of spending and reach financial freedom in doing so. Without budgeting, we’d be kind of shooting in the dark, never really knowing if we are going to make it.