The Basic Fundamentals & Importance of Budgeting
Whether it’s for yourself, or your business; monitoring your spending is extremely important in reaching your financial goals. Budgeting isn’t just about cutting costs and being cheap, it lets you track where your money is going and how much of it has gone. Don’t think of a good budget as strict, but rather, realistic and achievable. With proper budgeting practices you should notice a decrease in spending on unnecessary items, and more money to allocate to the things that you enjoy or prioritize.
Before you begin creating your budget you need to understand your financial goals. Do you simply want to reduce costs? Or save up for either a large purchase or to pay off outstanding debt? From a business perspective your goal might be to reach a certain return on investment (ROI), or to achieve a 10 per cent increase in profitability compared to the prior year. Whatever it may be, budgeting makes it significantly easier for two main reasons. Firstly, by determining your goal, you can create your budget in accordance to reaching that desired outcome. And secondly, by having a budget, you can follow your progress and adjust throughout to ensure you remain on track and don’t overspend in the wrong areas.
Creating the Budget Allocation
Once you understand what you are saving for, you can go ahead and start creating your budget. The first step in the creation phase is allocating your expenses. Now remember, in the beginning I said that budgeting isn’t about cutting costs or being cheap. What I mean by this, is that you should allocate your spending based on what is important to you and necessary to reaching your goal. With good budgeting you can afford anything you want, just not everything you want. For example, I am a big Toronto Raptors fan, so, if I am making a personal budget, I might allocate any spending I have after my basic life necessities towards playoff tickets. Although they can be expensive, this is something I would consider important to me. By doing this, I would then have less to spend on other luxurious items that aren’t required for basic living. But because I made a budget, this is a sacrifice I have already agreed upon making for the given time period, and when I see my credit card bill at the end of the month there won’t be any unexpected costs.
In order to know how much you can allocate to these luxury items; you need to first determine how much you plan on spending on the necessary items in life or within your business.
These items include:
Personal • Rent/Mortgage • Food and Groceries • Savings • Outstanding Debt • Personal Care • Utilities
• Rent/Lease • Salaries & Benefits • Marketing • Outstanding Debt • Procurement • Utilities
The remaining amount is what you would spend on things you enjoy or will help you reach your goal quicker. You should allocate your spending on your basic life items or business expenses with the same mindset. Meaning, prioritize which items are most important to you. For example, if you take your health very seriously, you would allocate more towards groceries, gym memberships, workout equipment, and less towards fast food restaurants, junk food, and non-active lifestyle activities (like going to the movies and ordering a large popcorn and Dr. Pepper). If you travel a lot and spend only a limited amount of time at home, there would be no reason to spend a ton of money on rent.
And from a business perspective, if for example, the nature of your business requires a lot of storage for your inventory, you would prioritize those expenses before others as it is a need for your business operations. It may seem like common sense, but it’s so easy to tap your credit card on a machine or purchase goods on account, that nowadays you don’t realize how much you’ve spent until you get your credit card bill or invoice. Budgeting will let you focus on where your money is going and see how much you are spending on one category versus another.
Once you’ve determined how you want to allocate your spending, you need to determine a consistent tracking period for when you will monitor your progress. I would recommend doing this on a monthly basis. If you don’t have enough free time then quarterly is a good alternative, but monthly would be ideal. This makes it easier to compare prior months to see how you’ve improved, and lets you catch bad habits on a more frequent basis.
It’s important for me to mention that it’s okay if you went off track in one period. As long and you have a solid method of tracking your spending and understanding of why you went over budget you should be able to adjust your spending habits to avoid this mistake reoccurring.
When creating a budget for a business, it should be done for the entire fiscal year, and the same monitoring strategy (on a monthly basis) should be done.
I would recommend using an Excel spreadsheet to track your expenses, if you have a good understanding of how to use it. Otherwise, some banks provide a template for you already, or you can download a budget app on your smartphone. Before choosing which app to download do your research and read some reviews you can make sure you download the best one for your strategy and goals.
I use Excel because I prefer doing it on my laptop rather than my cell phone (use whichever platform you prefer). I simply download my bank statements each month into Excel and categorize them. Once that is done, I create bar graphs and pie charts to see how much I am spending on each category by dollar amount and by percentage of total expenses. The goal here is to transform the data in a way that makes it easier to read and compare (see sample below).
If I notice one month, I spent too much on a luxury item that isn’t extremely important to me, I would go back to my bank detail and see what I spent it on and determine if it was reasonable or not. By doing this I am also putting it in the back of my mind for the upcoming month that I just overspent on this item, and maybe I should wait another one or two periods before I make my next purchase.
From a business perspective Excel will allow for the most customization when analyzing your budget progress depending on which ERP system you are using. Again, I would recommend you do your research to find the best strategy for your business needs. Below is the same sample as the one used above, except for a business.
I encourage you to do your own research before you start, as every budget varies depending on the individual or business and the goal they want to reach. This will help you discover what kind of strategy you want to pursue, and you can then determine how you are going to pursue it. Remember, budgeting isn’t meant to be strict, and you can afford anything you want, just not everything.
Adam Rifai Accounting & Business Analyst / Associate Consultant Toronto