How Budgeting Works

The purpose of this page is to explain the process of how budgeting works. To better understand budgeting one must first examine what is a budget, how to create one, keys to success and reasons why budgets fail.

What is a Budget?

A budget is a snapshot of your financial situation, whether you're rich, poor, or in between. Once you know your income and expenses, you can adjust your spending so that it doesn't exceed income. A good budget lists financial goals right at the top, so that you're regularly reminded of why you created a budget in the first place. A budget is not a way to take all the fun out of life, but a way to help you ultimately have a better life.

Budgets are for Every Income Level

Even people who are financially successful benefit from a budget. In fact, sticking to a well-formed spending plan helps those who are financially successful become more successful. Don't think of budgets as being just for people who are broke. They are for anyone who wants to improve their finances.

Creating a Budget

Budgeting requires four basic steps:

• Examining your income
• Identifying where your money goes
• Setting spending goals that stay within your means
• Tracking expenses to ensure you stay within your budget

Some people use software programs like Quicken to set up a budget, but a notebook, pencil, and calculator can work just as well if you're committed. Tracking expenditures involves steps like figuring out how the cash you take from the ATM evaporates within a day or two. It also involves being honest about which "necessities" really are luxuries and cutting back on them. Ideally, you should spend 90% of your income and save the rest. This may not be possible at first, but it should definitely be a goal.

Keys to Successful Budgeting

Those who are successful and creating and living within a budget have the following characteristics:

• Motivation. Set small goals at first, so when you reach them, you are motivated to continue on to bigger financial goals
• A positive attitude. Remembering the rewards of budgeting instead of the hardships will keep you committed to your spending plan.
• Realism. Having an unrealistic budget does you no good. If your goals are too big or your spending cuts are too draconian, you'll become too discouraged to continue with your budget.

Reasons why Budgets Fail

Common reasons that budgets fail include:

• Too much complexity. Budgeting takes effort, but you won't change your household's spending habits overnight. Start with simple goals. Once you accomplish them, move on to bigger goals.
• A focus on the negatives. Budgets ultimately aren't about denying yourself and your family, but about making things much better in the future.
• Using the wrong tools. If you live on your laptop or smart phone, then keeping your budget digitally makes more sense than buying a ledger. Likewise, if you find software frustrating, you can make a perfectly good budget with pencil and paper.
• Lack of goals. Budgeting for its own sake is a thankless chore. Even if your goal is to have $10 left over at the end of the month, that's a good start.
• Giving up too soon. Mistakes happen. Don't be discouraged if it takes trial and error to come up with a realistic budget.

Sources:

http://financialplan.about.com/od/budgetingyourmoney/tp/budgeting-101.htm
http://money.cnn.com/magazines/moneymag/money101/lesson2/index.htm
http://www.kiplinger.com/columns/starting/archive/2009/st0513.htm?si=1
http://www.onebudget.com/personal-finance/