Contrary to popular belief, personal budgets are not designed to make your life miserable, quite to the contrary. Personal budgets are great tools to help individuals properly manage their finances and avoid getting into debt trouble. In a world where credit cards get worn out from use within a few short months, having a cash budget as a personal guideline makes a great deal of sense.
“Cash Basis” Budget
A personal budget has to be prepared on a cash basis. Why? Cash is the only reliable barometer for what you can afford to spend on a monthly basis. After all, cash is what you earn and cash is what you have to spend. You can’t keep yourself financially stable if you look at credit cards as an extension of your buying power.
After incurring interest, your credit card balances still have to be paid off in cash and should your cash continually run out, you might find yourself facing debt issues. Note, the average American household uses as much as 14% of their disposable income just making payments on credit cards (Federal Reserve data as of May 2015). That isn’t a formula for success. If you keep it cash, you keep it real.
How to Prepare a Cash Basis Personal Budget That Works
You don’t have to be an accountant or finance major in order to learn how to prepare a proper cash basis personal budget. In fact, all you need is a pencil, paper, common sense and a little dose of reality.
If you are not sure how to proceed, debt management companies like Rescue One Financial can be helpful. Before you begin the process, you will need to accumulate your total disposable income (all sources) and monthly expenses (rent or mortgage payment, car payment, insurance, utilities, food, transportation, school and miscellaneous).
Step 1: List Your Sources of Income – In the top section of your page, you need to list all sources of income. If your primary income comes on a semi-monthly basis, you should have two columns, one for each paycheck. List any other sources under the most applicable column with a sub-total.
Step 2: List All of Your Expenses in Detail – The best way to list your expenses is by due date. This will allow you to put the expenses in the appropriate semi-monthly column and sub-total. This is a process called “matching income with expenses.” (Example: Your paychecks come in on the 15th and last day of each month. In the column with the income that comes in on the 15th, you should list any expenses that you need to pay with due dates between the 21st and the 5th of the next month. For the paycheck that comes in on the last day of the month, list expenses with due dates between the 6th and 20th). By taking this approach, you will have a realistic guide that shows the money coming in and which expenses should be going out at that same time. Strict adherence to this method will help you avoid late payments and late charges.
Step 3: Calculate Excess Disposable Income – The subtotal is calculated by subtracting your total expenses from total income. The positive difference is your excess disposable income. If the sub-total comes back negative, you are operating from a negative position and need to increase your income or lower your expenses in a hurry.
Step 4: Determine Savings – From your excess disposable income, you need to subtract something to contribute to an emergency savings account. If you are serious about saving, the amount should be at least 50% of the available amount. If you already contribute pre-tax dollars to a 401K or IRA retirement savings, it would be acceptable to save a little less.
Step 5: Fun Money – The remaining amount after deducting savings should be considered your personal monies. You should feel comfortable spending this money as you see fit, having already acted responsibly by paying your bills on time and putting extra savings aside.
There you have it. After an investment of 30 minutes and $1 of office supplies, you now have a realistic cash basis personal budget that will help you stay on track with your finances.
In you would like more information about managing your finances and staying out of debt, you could benefit by scheduling a consultation appointment with a professional debt counselor here at Rescue One Financial. Our goal is to better equip our clients with the tools necessary to maintain financial stability.