Sunday, October 30, 2011

Turning Your Money Blues Back To Green

There have been many stories in the news recently about the financial crisis in Greece that is causing problems with the world financial markets.  Four months ago there was great chaos caused by the "debate" of our own government about raising the US Debt Ceiling (see previous post).  What these"events" have in common is very simple - a lack of proper budgeting.  

The financial problems in Greece and the United States are not because those governments did not create a budget;  they have occurred  because their budgets have not been balanced  - both countries have been spending more money than they had available.  To manage money properly a budget must be developed as well as methods to monitor progress towards the budget.

A budget is defined as "An itemized summary of estimated or intended expenditures for a given period along with proposals for financing them."  Many organizations develop a budget to manage their money.  They "forecast" the amount of money they will receive  (called Revenue), how much money they will spend (called Expenses) and how much profit they will earn (Revenue - Expenses).  Generally on a monthly basis financial statements are created to report how the organization is performing compared to the budget as a sort of financial report card.  Managers in the organization review these reports to determine if changes to their current plans are needed to keep on track to meet the budget.

Using a budget is also the best way for you to manage your own personal finances.  Again,  you not only have to develop a budget but you have to have the discipline to monitor and manage it.  How do you do that?  First, let's talk about how you create the budget.

Start by determining you total take home pay for a month.  You may be paid each week (multiply by 4) or twice a week (multiply by 2) or only once a month.  That monthly total is your Revenue number.  Next, you need to determine your Total Fixed Expenses for each month.  These are the bills you have each month that do not change or are "fixed".  Examples are your rent or mortgage payment, car payment, child support, annual memberships (broken down into a monthly amount) cable bill, phone bill, electricity, water, and insurance.  Even though some of these bills like phone, electricity and water may vary slightly, you still have to pay them every month and that's why I categorize them as "fixed".  You will not get through a month without receiving a bill for these items.  You can estimate the monthly amount for them by calculating an average amount and then add a little to it to use in the budget for that item.

Now if you do not keep copies of your monthly bills, this may be a bit difficult.  If that's the case, just get an envelope, label it "Bills" and start collecting them.  After about 45 days you should have all your bills in that envelope at least once and possibly twice.  Once you do, sit down at a table and take them all out and make sure you have everything.  If you have any payments made automatically (like phone bill charged to a credit card and no paper bill sent) you have to determine those amounts by reviewing your email or on-line statements and include them.

You also use these bills to calculate the averages for the bills that vary slightly.  For example, look at your electric bill.  Let's say it's $130.  Well it may be a little more in the summer ($165) when the air conditioning is working.  If you live in an apartment with electric heat, it may be even more in the winter ($185) .  So perhaps you add another 10% to that number so that average is equal to the sum of all your electric bills divided by 12.

This brings me to another very important point: you need to start keeping copies of your bills each month.  Review these bills against your budget every month and make sure all the amounts you have been using in your budget for "fixed" expenses are correct.  If not, you make adjustments to your budget.  After 6 months, review all your bills for those 6 months again to be sure your estimates are correct and make any adjustments necessary.

Now that you  have all your information for Total Fixed Expense and your Total Revenue you subtract the Expenses from the Revenue  and you get your Discretionary Spending.  This is the money you can totally control each month.  This is the money you use for groceries, going out to eat, clothes, electronics, and all the other "stuff" you purchase.  You also take your "savings" from this money.  You should target to set aside 10% of your Discretionary Spending and "pay yourself first" this way before you spend money on other things.  Why should you do this?  You need to plan for the unexpected.  The doctor visit you had to have.  The flat tire that had to be replaced.  The unexpected expense for the field trip at school.  If you don't pay yourself first, these things can wreck havoc on your finances when they just "pop up."

Some people have asked me "Why is food discretionary?"  Well, you can control what you eat, how much you eat and how often you go "out" to eat.  No one is forcing you to eat out every day at lunch or go by Starbucks every morning on your way to work.  When I lived alone, my grocery bill was around $125 a month.  I planned my meals, bought the same things each time I went to the grocery store and I ate simply.  I didn't starve, ate "good" food and was in very good health.  I still brew coffee at home every morning.  I don't go "out" for lunch.  I live close enough to work to come home for lunch and when I worked further away I packed a simple lunch.  If you eat out every day and spend $7 on lunch that is $45 a week and almost $100 a month!!  If you packed a lunch you could "save" at least half that amount if not more.

If you're having trouble figuring out how to calculate all this, here's a useful tool you can use. Just fill out all the items in the GREEN boxes with your numbers.

Once you have developed your budget and you know how much you have available to spend each month, you need to develop a method to manage your budget day to day, week to week, month to month.  In other words, using some round numbers, let's say you have $500 of Discretionary Spending each month.  First deduct 10% for savings and you're left with $450.  How are you going to track your spending to make sure you don't spend more than that $450?

Well, one way is to use a credit card for all your purchases.  Many times, a credit card has some type of rewards system for using it either cash back like with the Discover Card or points you can use for other discounts or airline travel or whatever.  The credit card usually has a way you can monitor your spending activity on line so you can check anytime to see how much you have spent so far for the month.  Another advantage to credit cards is they have a little better fraud protection than using a debit card as I discussed in this post.  The risk with the credit card is it is VERY easy to go over budget since you can charge easily and you don't "see" anything leaving your wallet.  You can find yourself in over your head with debt very quickly so you have to have a lot of personal discipline to use this method.

Another way is to use a debit card in the same manner as the credit card.  You can still track your transactions on line to manage your budget.  With this method, the money comes out of your account immediately and the fraud protection is not quite as good as the credit card and it still requires discipline to not spend more than you have available.  If you do overspend, instead of adding debt like you would on the credit card you may wind up paying fees for over-drafting your account and possibly reducing your savings if you have your savings set up to cover your checking account for overdraft protection.

The final method is to use cash.  You do not have to keep up with any receipts or look on line to see how you're doing;  you just have to look in your wallet to see how much money you have left.  Now, I personally would not walk around with $450 cash.  I would take some like perhaps $60 and leave the rest in a "safe" place and refill my wallet as necessary.  For some people this is the best method because it requires less discipline since you have a finite amount of money and you "see" it leaving your wallet.

Which method is the best?  Well, that depends on you.  Each one has advantages and disadvantages.  What's important is that you choose the one that is most likely to work best for YOU to help you manage your money the most effectively.  You may try one method and find out it doesn't work well for you and switch to another.  There's nothing wrong with that at all.  Each of us is different and we each have to develop our own unique methods to manage our money successfully.  Whatever method you choose, be sure you are conscious of your budget each time you spend money.  That way you will be prepared for the unexpected expenses that happen to all of us and you'll have the peace of mind knowing you were prepared.

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