My readers may have seen thick files prepared by accountants to prepare the annual budget for a company. I have, as an accountant, prepared such files. There may be a large Excel file with 100 or more interlinked pages all sending numbers flowing through to the annual budget. The excel file is printed out and filed with all manner of supporting documentation. A lot of calculations and meetings, and a lot of time and effort, went into preparing that file.
An individual certainly does not need to prepare large spreadsheets and thick files to manage a monthly salary. Such efforts are worthwhile for an organisation with millions in annual turnover. However, one does not spend hours in the hope of saving a few dollars. Life is to be lived so one can use simpler methods and accept that one will save a few extra dollars less each week. One would not do two hours overtime at work for $3 so one ought not spend two hours to save an extra $3. The systematic methodology used to prepare a large budget is undoubtedly useful to the individual. The difference really will be only a few dollars a week if one develops good spending and savings habits.
A company budget begins with estimates of all revenues and expenses in the form of a statement of income and expenditure. This is simply a list of all sources of income and the amounts which are added up to find total income. Next is the list of all expenses which are also added together. The difference is the budgeted profit for the year. A personal budget follows the same format except the difference between income and expenses is the amount one expects to save in the budget period.
A company records every transaction and each of those transactions is classified into the appropriate general ledger account in its financial records. There is a general ledger account for each classification of expenses, revenues, assets, liabilities and proprietorship. The accountant has accurate records of all past expenses and revenues which is a very useful starting point for budget preparation. Use that historical data to prepare the first draft, and then the hard work begins. That historical data represents the financial quantification of what the company has been doing however it is obvious that the activities of a company continue evolving. The budget represents, not what the company has done, but what it will be doing in the coming year. Much of the activity is much the which makes the historical data a useful starting point, but not the end point. The thick budget file looks at what will be done and quantifies the costs and revenues for the coming year. The files and the meetings analyse what will change, what will stay the same, and attaches dollar values to those activities.
Every expense is analysed, one expense at a time with a workpaper and supporting documentation foe each expense. This process is repeated for each item of revenue. Each workpaper essentially sets out the proposed activities and related purchases pertaining to that expense. One does not simply enter numbers, one looks at what will be done and works out the cost. One then looks at the overall budget for overall reasonableness and whether the budgeted profit is satisfactory. And then perhaps works through the budget again to find more ways of fine tuning the expenses and revenues.
As an illustrative example let us consider postage costs which may included six mail outs of 10,000 pamphlets each requiring postage of 50 cents each. We multiply that out to find the total postal costs of these mail outs is $30,000. If we propose to instead do do eight mailouts we must increase the postage budget to $40,000 and that increase in activity will increase other costs. We need to increase other expense budgets to cover more envelopes, pamphlet printing and labour costs to stuff these pamphlets into envelopes. If we have reason to believe the cost of stamps will rise to 55 cents then we must further increase the postage budget. That, in a simplistic nutshell, is a review of a budgeted expense. Approach the review of each of your expenses in a similar way.
A personal budget is essentially similar. Estimate and list all your sources of income for the coming year and add them up. Repeat this for your expenses. If you have no historical data you will be doing quite a bit of guesswork. For example if you wish to estimate your electricity bill for the coming year pull out all of your electricity bills for the previous year and add them up to find your expense for the prior year and then allow for an estimated price increase. Very easy if your electricity supplier has sent you a notice advising its proposed price increases otherwise you make an estimate. If you don’t have the bills, or payment records, and can’t remember how you paid you are reduced to taking a guess. You can look up estimates on the Internet which I just did for Sydney in Australia and found estimates ranging from $400 to $3,600 per year. The low estimates were from people who never use heaters or air conditioners so you must derive your own estimates depending on your appliance usage. This clearly shows that running heaters and air conditioners adds up to a much larger power bill.
Draw up the budget anyway incorporating your best guesses because you need to start now. You can amend the budget later and keep records so that next year you will have a better budget. Many of those errors can be amended within weeks as will be shown later in this essay. The differences between what you do spend and what you think you will spend in the coming weeks may prove interesting and useful.
The important point is to get started and learn and improve as you go. Just list your estimated income and expenses and up them up. Don’t stress about the numbers, just get numbers down on that piece of paper. The general idea is to get a complete list of your income and expenses so you are not overlooking things. Don’t stress about overlooking a few minor expenses at this stage, you will pick them up later as you go along.
A company will organise the enormous number of transactions by classifying them This is a classification of essentially similar transactions into an expense account. This is simply a process of organising a mass of data into bite size chunks. You should do the same by looking at each of your major expense categories which may include:
- miscellaneous to cover all other minor expenses
Go each category one at a time and consider what you buy that makes up each of those expenses. Get out such bills and records as you can to get a more accurate estimate of your forthcoming expenses. It seems worthwhile to ask the following questions in respect of each expense:
- Do I need this?
- Do I really want this? More specifically, how does it add to my quality of life?
- Why am I buying this?
- Is there a better alternative way of satisfying my purpose in buying this?
- Is this worth the money given my desire to save?
- What if I simply could not have this? Would I really miss it?
When this process is finished you will have your first budget. The difference between your budgeted income and your budgeted expenses is the amount you expect to save. The first budget prepared by a novice can be expected to contain a number of incorrect estimates. Do not dwell on this but move on. You can amend the budget as you gain a deeper understanding of your expenditure patterns and work on improving your spending habits. Just keep working on each expense category.
Budgeting, like any other skill, is improved with learning and practice. Keep learning, keep doing, and keep going until you do have a very good and complete budget. Start now because the only way you can succeed at anything is by getting started and then continuing.