What is budgeting?

Budgeting is often cited as the key to your finances. While a relatively simple tool, it can help you manage your money effectively and efficiently, highlight where you can free up funds to put into savings and better prepare you for potential cashflow shortfall. Creating a budget itself is relatively straightforward, though it can take a little time to get an accurate portrayal of your finances. This is usually because you’ll need to use previous bank statements or track your spending over a month or more to find out exactly what you spend and where you spend it. However, it’s time well spent because budgeting can improve your financial resilience which is something most of us have lost a little of during the pandemic.

Definition of budgeting

In simple terms, budgeting is a plan of your income and expenditure. You can budget weekly, monthly, or even yearly, depending on when your income is paid and when your essential expenditure falls. For example, you may be paid monthly, but your car insurance, MOT and TV license might be paid annually. You may therefore opt for a yearly budget (as well as a monthly one), so you don’t lose track of when your payments are due or leave yourself with cashflow issues when a direct debit goes out unexpectedly.

How to calculate a budget

Working out how to budget is also quite simple. You need to categorise your income which might include your earnings, any tax credits or benefits, and your expenditure, which is everything that leaves your bank account. Your expenditure falls across two main categories:

• Discretionary expenditure
• Non-discretionary expenditure

Your discretionary expenditure is the money you pay for the things you need or cannot live without. For example, your rent or mortgage payments, utility bills for water and energy and your food costs. Your non-discretionary expenditure is what you spend your disposable income on. This can cover an array of outgoings, but might include takeaways, holidays, cinema trips etc. While these things are important, they’re not classed as essential, and are often the first thing you’ll need to cut back on if you’re trying to make savings or you are facing an income reduction.

If you’re comfortably living within your means, then you probably won’t need to make any amendments to how you spend your money. The idea of a budget in this case is so you can track your spending and know where you can redistribute funds if you find yourself faced with an unexpected bill or if you decide to start saving towards something.

If you find your income doesn’t always sufficiently cover your expenditure, then your budget can play an important role in establishing where your spending might be going wrong, and where you need to cut down. For example, if you notice you spend a large chunk of your earnings on energy bills, it might be time to think about switching providers or consider how you can reduce your energy consumption (turning off lights when you leave the room, only boiling the water you need in the kettle, etc.).

Of course, some months may have unavoidably high outgoings, and this is where your savings can help. But, if you do use your savings, consider how you’re going to rebuild the funds over the coming months. If you don’t quite have the savings yet and you need to borrow, you’ll need to factor the repayments into your budget. They form part of your financial responsibilities and having them established in your financial plan means you’ll be less likely to miss them.

Budgeting and Borrowing

Borrowing in general can skew your budget – for better or for worse. If you need to borrow to avoid arrears or loss of income, then it’s usually a fairly sensible option. But borrowing has to be repaid, and often with interest, so you must make sure the repayments are affordable. This is where budgeting can help both before and after taking out a loan. You’ll know if you have the disposable income to cover the payments from your previous budgets, and you can adjust your budget to include the new repayments going forward.

While popular payday loans can impact your budget as the added financial commitments increase your essential expenditure and reduce your disposable income. Borrowing can be a quick solution to temporary cashflow issues, but ideally you shouldn’t rely on credit as a remedy. Hopefully, after careful budgeting for a few weeks or months, you’ll be able to save sufficiently to avoid borrowing altogether!