What Is the Purpose of Budgeting?
The main purposes of budgeting are resource allocation, planning, coordination, control and motivation. However, budgeting is also an important tool for decision-making, monitoring business performance, and forecasting income and expenditures. With proper budgeting, it can be easier to manage limited resources efficiently. But what does this mean for you as far as your personal finances are concerned? Take a deeper look at the role of budgeting and how it can transform your financial health.
What Is a Budget?
In essence, a budget is a plan. It takes into account how much money you make each month and helps you plan how much of it to spend and on what. Your budget also reflects how much money you’ll need to put towards things like bills, living expenses and other costs.
One of the first steps in creating a budget is to figure out your own spending habits. Some regular expenses, such as rent or car payments, are straightforward to figure out, especially if you pay the same amount every month. Other expenses may take a little more work to pin down because they vary from month to month or season to season.
Rather than using wishful thinking to guess how much you spend on things like dining or entertainment each month, try to write down everything you spend money on for at least one month. Saving your receipts and jotting down each purchase at the end of the night can be a helpful way to get a realistic view of where your money tends to go.
Why Is Budgeting Important?
What is the purpose of budgeting? If you’ve ever come up short on cash right when a bill is due, you know firsthand. One of the primary reasons budgeting is important is to ensure that you always have enough money to meet your financial needs and pursue your financial goals.
However, the benefits of budgeting don’t end there. Below are the six main purposes of a budget:
Goal Setting: When you’re living paycheck to paycheck, it can be hard to think about long-term goals like taking a vacation or buying a new car. Budgeting allows you to get clearer about your finances so you can see where to cut back and tuck a little money away to meet that goal.
Limits to Overspending: Many people use their budget to track not only what expenses they have coming up but also when those expenses are due. Ensuring you have enough to cover your bills on time is an effective way to save money on late fees.
Planning for the Future: Once you get a better handle on your finances, you can also start planning for the long term. You might even consider putting aside money in an IRA or investing it for long-term returns.
Emergency Preparation: It’s important to be able to cover a financial emergency. You should begin by saving up six months’ worth of living expenses and keeping it in a separate savings account. If you ever find yourself out of a job or have an emergency medical bill, you’ll be able to cover the costs until the situation changes.
A Reduction in Stress: While the thought of budgeting may not sound like much fun, it’s better than losing sleep over upcoming expenses you can’t afford.
Limiting Unhelpful Habits: The first few months of budgeting tend to present many people with plenty of revelations about behaviors that have and haven’t helped them. By keeping a closer eye on your money, you’ll begin to notice and address the spending habits you want to change for the better.
How to Budget Money Wisely
There are many different ways to budget your money, and it’s important to find the one that works for you so you’ll stick with it for the long term. One thing you’ll want to keep in mind when planning out your budget is to make sure you don’t forget to include things like entertainment.
One time-honored method is called the 50/30/20 rule. It’s a simple framework that advises budgeting:
- 50% of your income for needs and necessary expenses
- 30% for things you want
- 20% for saving and investing
While this is a good place to start, it can be helpful to break down each of the three categories above into smaller subcategories. For instance, rather than simply putting aside half of your income for bills, you may want to create categories like:
- Phone bill
- Electricity bill
These smaller categories will help you stay realistic about how much money you plan to put into the overall category of “needs.” Over time, you may find that you want to change the amount you budget towards certain categories. Maybe you discover that you aren’t setting aside enough money for things like investing and can cut down on subcategories like dining out to make up the difference.
Budgeting and Forecasting: Creating a Budget Planner
Creating a budget doesn’t do as much good unless you make new habits and stick to it The good news is that there are plenty of helpful resources that can help you keep track of your personal budget. Check out the following resources to get started:
Nerdwallet: Nerdwallet offers a free budget planning worksheet that can help you start your budget.
Mint: One of the most popular free budgeting apps, Mint makes keeping track of your budget and bills simple.
YNAB: YNAB, which stands for “You Need a Budget,” is a paid subscription service, but its users swear by it. It not only helps you stay on track with budgeting but also teaches you ways to stay ahead of your finances for the long haul.
Goodbudget: Never get caught off guard again with Goodbudget, a smartphone app that uses the time-tested envelope method in digital form.
What Is Budgeting in Business?
Budgeting is just as important for businesses as it is for individuals. In the same way a personal budget helps you keep track of your own finances, a business budget helps managers (and small business owners) ensure that a company takes in more money than it spends.
By developing a financial framework, a business can make sure it’s making the wisest possible use of expenditures without affecting profit. Budgeting allows a business owner to plan for expenses like merchandise to sell, advertising, rent and other costs, and the company can then formulate a plan for covering these costs. By creating a business plan, a business can also set goals by understanding how much profit it needs each to make in order to effectively stick to the budget.
Budgeting Methods for Business
Just as there are different ways for individuals to create a budget, there are also a variety of strategies that businesses tend to use. Some businesses even allow their employees to take on active roles in the budgeting process by using a method called participative budgeting.
Some additional popular budgeting methods for business include:
- Incremental Budgeting: Adjusting the company’s existing budget to reflect either growth or a drop in the company’s earnings
- Value Proposition Budgeting: Determining how much funding each budget category receives based on the amount of overall value it brings to the business
- Activity-Based Budgeting: Setting a goal for the company and then working backward by funding the types of activities that will help to meet that goal
- Zero-Based Budgeting: Justifying every single dollar spent to emerge with no additional money or debt at the end of each period
- Cash Flow Budgeting: Finding extra means of generating income when a business’ budget is struggling to stay on track
- Surplus Budgeting: Determines what a company can do with extra money when it ends up with the pleasant surprise of earning more than expected