How Do You Make a Budget and Stick to It?
A successful cash-flow management plan starts with a written budget. In the budget, one defines sources of cash inflows and expenses (cash outflows). The inflows and outflows must balance. There are three sources of inflows: income, savings, and borrowing. There are many outflow items, but they are usually described as expenses and grouped together in a few common categories in order to simplify the written plan. Some expense items may be used as income tax deductions and are customarily grouped to make it easier to identify for income tax return calculations.
Expenses may be fixed or variable. Fixed expenses recur each period (month) and include items such as mortgage or rent payments, automobile payments, utility bills, etc. Variable expenses generally do not recur each period or their amounts are very different from month to month. Variable expenses include entertainment and vacation costs, and purchases of clothing and household items, etc.
Expenses may also be discretionary or non-discretionary, depending on whether one has a choice of incurring the expense or an option of when to incur the expense. For example, paying the utility bill is non-discretionary, since if one doesn't pay it, the utility company can turn off service. Purchasing a replacement automobile is discretionary (left up to your own judgment), since one can choose to buy a new or used car, a luxury or economy car, or can choose the timing of the purchase—now or in the future.
Budgets for a household and for a business may look different, but they use the same basic principles. Some people like to group fixed expenses together and variable expenses with each other. Others like to categorize all discretionary expenses together and all non-discretionary expenses with each other, too. The method you use is a matter of personal taste and convenience to suit your particular purpose and reporting needs.
The basic layout has all inflows grouped together at the top. Outflows are grouped by expenses and are listed below the inflows. Here is an example:
When making your first budget, you would initially make a guess for each of the inflow and outflow items. A better method is to review past inflows and expenses over a reasonable period of time (several months or years) and use the average as an educated guess. Recording inflows and outflows in this way helps to project future cash-flow needs. It also suggests which expenses need to be watched closely in order to economize and avoid waste.
Pay yourself first. Most financial advisors agree that the best way to avoid financial problems and to save for future expenses is to "pay yourself first." This means that a certain amount of money from your gross income should be withheld and set aside into a savings plan. In your written budget, this will appear as a negative entry in savings, since the cash flow is going into savings.
By keeping a written record of your income and expenses, you are better able to project when you will need additional inflows from savings or borrowing, and which expenses can be reduced or postponed to a future period when you have better inflows.