What Is A Budget & Why Is Budgeting Important?

Everyone says you should have a budget, and that’s certainly good advice. But if you’ve never had a budget, you may not be entirely sure what it is and what it’s designed to accomplish.

In this article, we are going to answer the question of what is a budget, talk about why you need one, and share some specific strategies that may work for you.

Part of the issue for a lot of people may be that the term “budget” is thrown around so frequently, and maybe even haphazardly. We’re always told that budgets don’t work. After all, the federal government virtually never balances its budget, and many businesses frequently come in over budget

What Is a Budget?

A budget is an estimation of revenue and expenses over a specified future period of time and is usually compiled and re-evaluated on a periodic basis. Budgets can be made for a person, a group of people, a business, a government, or just about anything else that makes and spends money.

To manage your monthly expenses, prepare for life’s unpredictable events, and be able to afford big-ticket items without going into debt, budgeting is important.

Keeping track of how much you earn and spend doesn’t have to be drudgery, doesn’t require you to be good at math, and doesn’t mean you can’t buy the things you want. It just means that you’ll know where your money goes, and you’ll have greater control over your finances.

Understanding Budgeting

A budget is a microeconomic concept that shows the trade-off made when one good is exchanged for another. In terms of the bottom line—or the end result of this trade-off—a surplus budget means profits are anticipated, a balanced budget means revenues are expected to equal expenses, and a deficit budget means expenses will exceed revenues.

What Is The Purpose Of A Budget?

The main purpose of a budget is to gain the upper hand on your financial situation. Living paycheck-to-paycheck, the way most Americans do is not only financially dangerous, but it’s also incredibly stressful. It’s one of the major reasons why stress seems to be a bigger problem now than ever.

There are all kinds of causes for stress, but one of the biggest is financial. The problem is that it’s relentless. It’s not just that you fall behind in one month, but rather that it’s a constant struggle every month and t hat can wear anyone down.

How To Start the Budgeting Process

In a real way, a budget is like taking a financial timeout. You’ll start the process by doing an in-depth analysis of your current financial behavior.

Mostly, that’s about figuring out exactly how you spend the money you do have. And once you do, you’ll be in a better position to evaluate how you can be more efficient with your finances.

A good term that relates to budgeting is “creating margin in your finances.” Like the extra space that surrounds the text on the page of a book, margin is the extra money in your budget.

If you don’t have a budget, you probably don’t have any financial margin. The purpose of a budget is to provide exactly that. Until you implement a budget of your own, it’s highly unlikely you’ll ever make any progress on the financial side of your life.

The Pros & Cons Of Having A Budget

Most people focus on the negative side of budgeting, but that’s approaching it entirely from the wrong angle.

The Negatives of Budgeting

Changing your finances, which is always uncomfortable. And naturally, changes in your finances will inevitably lead to changes in your lifestyle.
Learning to live on less than you earn. That’s a difficult concept if you’ve never done it before.
Adopting the discipline to say “no” to yourself and your family when you’re working to justify spending money on a “want” that you’re trying to convert into a “need.”
The initial sense of a loss of freedom when first implementing your budget.
Learning to live without those little goodies and indulgences you’ve been treating yourself to over the years.
If you focus on the negatives, you may never start budgeting. But that’s why it’s mission-critical to focus instead on the positives.

The Advantages of Budgeting

Once you implement a budget, you’ll begin to develop a sense of control over your finances that you’ve never known. It can be incredibly empowering.
You’ll begin building savings, which will represent tangible evidence of the greater control you’re gaining over your finances.
If you were in debt when you began budgeting, you’ll begin to see your balances decline – along with your monthly payments on credit cards. You’ll start to realize you can get out of debt.
When your savings reach a comfortable level, and your debts are well on their way to being paid off, you may begin investing. That’s when you’ll begin creating wealth for the future.
You’ll come to realize that your budget, as painful as it might be, is creating more options in your life.
Your stress level will decline, enabling you to sleep better at night and to feel better about yourself.
As your financial situation begins to improve, you’ll once again be able to indulge yourself in some extras, only this time you’ll do it without guilt.

If you’ve been struggling with starting a budget because of how bad it will feel, change your focus, and think more about how good it will feel when you have it up and running. In other words, focus on the benefits at the end, not the struggles at the beginning.

Short of having a winning lottery ticket or a large inheritance, no one achieves financial independence without an investment of time and effort. And trust me, financial freedom is a worthy goal. But that will never happen until you get control over your budget.

How to Budget in 7 Steps

The specifics of your budget will depend on your personal financial situation and goals. In most cases, though, the steps for creating a budget are the same. You can make a budget by following seven simple steps.

Add up your total income. This should include all sources, such as a paycheck, tips, Social Security, disability, alimony, or investment income.
Track your spending. Spend a month (or two or three) keeping track of everything you spend, whether you pay with a credit card or cash, to find what your real expenses are. Be sure to include automatic payments, subscriptions, and utilities.
Set financial goals. Do you want to save money? Pay off debt? Stop overspending? Decide on realistic goals. Remember, you can adjust these over time. Pick the most pressing goals, such as paying off debt or creating an emergency fund, first.
Calculate mandatory expenses. These are expenses you must pay each month, such as mortgage / rent, insurance premiums, taxes, childcare, or your cell phone bill. Subtract these from your total income.
Identify debt payments. If you are paying off debt, such as student loans or a credit card bill, find the minimum payment for each debt. Subtract that from your income as well.
Make a spending plan. The amount of income you have left is what you can spend on discretionary expenses. These can include your goals, such as debt payment or savings. It should also include things like groceries, entertainment, gas, or surprise expenses. Give every dollar a job, based on your goals and what you discovered when you tracked your spending.
Adjust each month. Each month, look at your spending and goals, re-evaluate and adjust where you assign your discretionary spending. A flexible budget will help you avoid overspending.

What Are The 3 Types Of Budgets?

There are more than three types of budgets, so many in fact that it’s probably impossible to put a number on it. Virtually anyone who knows anything about finance has published a book or an online course to give you their version of the ultimate budget.

50-20-30 Budget

The numbers, 50-20-30, represent percentages of your net income allocated to general spending categories. Those categories are as follows:

50% of your after-tax income goes to necessary expenses, like housing, utilities, food, minimum debt payments, insurance premiums, and the like.
20% is allocated to savings and/or debt repayment. For debt payment, it represents payments over and above the minimum required monthly payments. The idea is to increase your payments to pay down your debts faster.
30% goes to “wants.” These are the extras in life that you don’t need, but you buy them because they make life more pleasant. This category includes vacations, entertainment, concert tickets, sporting events, and going to the movies. You get the picture.

The 50-20-30 budget emphasizes the big picture. Most budgeting methods focus on the details of budgeting, like the individual expense line items.

With this method, personal expenses aren’t as necessary. For example, the 30% allocation to wants you can spend any way you choose. You can decide which pleasures you wish to pay for in life, without having to go on the financial equivalent of a diet.

There’s also a lot of flexibility in this budget method. If you can’t fit your necessities neatly in 50% of your after-tax income, you can move some of your allocations from your desired category.

The method emphasizes saving money. Most people try to get by saving just 10% or so of their paychecks. That’s certainly a step in the right direction, but in my own experience, you’ll need to save a lot more to build wealth. 20% is the minimum in that direction.

The Envelope Method

Long ago and far away – when people typically paid their bills in cash – many used this method as a standard budgeting procedure. It involved putting actual currency into individual envelopes earmarked for each household expense.

It’s conceivable you could’ve had 15 to 20 cash bearing envelopes to match all of your expenses. A few people still handle their finances that way, but the envelope method has evolved in recent decades.

Though far fewer people put cash in envelopes, the basic methodology remains the same. You set up a budget in which each expense has an “envelope” that you need to fill with sufficient funds to pay the expense it represents.

One of the advantages is that if you go over budget in one expense category, you can usually find additional funds from another expense that’s lower than expected.

And for what it’s worth, you don’t need to set up a system of physical envelopes anymore. There are envelope budgeting apps you can use to do it digitally. The most prominent is an app known as Mvelopes.

It works by “giving a purpose to each dollar in your budget,” which is precisely what the paper envelope method does. It will enable you to take an old school budgeting system and do it digitally.

Zero-Based Budget

Using the zero-based budget, if you manage your money correctly, your budget will zero out every month. That’s because the method forces you to account for every dollar in your budget. Every dollar must go toward a specific expense, or moved into savings or put toward debt reduction.

The zero-based budget works on the assumption that any money in your budget that doesn’t have a specific purpose is likely to disappear into excess spending.

For this reason, it tends to be more restrictive than other budget types. It may best be used if you’ve had difficulty managing your finances in the past, and lack the discipline to handle unallocated funds.

Sticking to a Budget

Now you understand the finer points of budgeting. You’ve accomplished all of the above, even put together a nice spreadsheet that lays out your budget for the next 15 years.

The only problem is that sticking to that budget isn’t as easy you thought. That credit card still calls your name, and your “clothes” category seems awfully small and you feel deprived. Budgets, you decide, are no fun.

The good news is you don’t have to throw it all out the window just because you’ve messed up once or twice. The point of the budget is to keep you out of overwhelming debt and help you build a financial future that will give you more freedom, not less.

So think about how you want your future to be and remember that keeping to your budget will help you get there. Adding to your debt load, on the other hand, will mean that your future could be even tighter.