What Is a Budget?

5paisa Research Team Date: 16 Jan, 2024 02:50 PM IST


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50/30/20 Rule

The 50-30-20 rule says that you should allocate 50% of your income to needs, 30% to wants, and 20% to savings. Money for your future aspirations is also included in the savings category.

What do you mean by budget?

A budget definition is a macroeconomic concept that depicts the trade-off made in the case of the exchange of goods. The budget meaning in financial terms refers to creating a plan to spend your money, whereas the spending plan is the budget. Creating a spending plan allows you to determine whether you will have enough money to do activities you wish to and prioritize your task spending accordingly. Budgeting is pertinent to managing your monthly expenses, planning for unexpected life events, and affording high-ticket items without debt. 

The budget ranges from a week to a month or even a year. Typically, individuals prefer to prepare monthly budgets, and most organizations prepare an annual budget and review it at periodic intervals. You may write your budget by hand or use a spreadsheet or a budgeting app based on your preference and comfort.

Budgets may be of two types – static and flexible. A static budget remains unchanged over the life of the budget. Irrespective of the changes during the budgeting period, originally calculated accounts and figures remain the same. Conversely, a flexible budget has relational value to certain variables. A drastic change in variables impacts the overall budget. Both budget types are useful to management. A static budget gauges the usefulness of the original budget, and a flexible budget offers practical insights into business operations. 


What's the purpose of a budget?

The common notion for budgeting is deprivation. However, budgeting is about controlling your finances. Therefore, preparing a budget must not feel like a punishment. Any budget earmarks money for ad hoc and impulsive spending. 

Secondly, a budget need not be rigid. An ideal budget must adapt to a change in circumstance. The primary purpose of a budget is flexibility and customization with enough room for adaptation.


Why is budgeting important?

Budgeting is not only useful for individuals who struggle financially. A budget is a stepping stone to your financial goals. It allows you to live within your means and derive maximum benefits from available resources. Budgeting can help as below:

Financial Awareness: Budgeting helps to understand your relationship with money. With a budget, you know about your income, spending scope, and saving opportunities. Regular tracking helps to spot patterns and make changes if required. Ultimately, budgeting helps avoid frivolous expenses and inculcates financial discipline. 

Emergencies: An ideal budget earmarks funds for an emergency and plans for goals like retirement or vacation. Flexible budgets allow you to organize allocation based on your immediate needs. 

Reduce Debt Exposure: A budget helps you to map out expenses and reduces overspending. In effect, it limits or eliminates exposure to debt or credit facilities. 

Relieves Stress: Formulating a budget and adhering to it ensures financial independence. While budgeting is not a cure-all, it helps you manage financial decisions and prepare for challenges. 

Reorganize Expenses: Budgeting helps to forecast those months with tight finances and ones with extra liquidity. To ensure manageable and smooth finances, you may adopt methods to even out the highs and lows in a budget.


What about Budget Forecasting and Planning?

Regular budgeting makes it possible to keep a thorough track of your finances. Over time, you may wish to create budgets for an extended period. Using a realistic budget for an extended period aids long-term financial planning. With sensible assumptions about your income and expenses, you may even plan for tertiary goals such as setting up a business, buying recreational property, or investing in a retirement home. 

Sticking to a budget is equally important; budget forecasting and planning are futile. Simultaneously, deviation from the budget once or twice may not necessarily wreak havoc. Below are some important points for budget forecasting and planning:

Resist the urge to use overwhelming debt and instead concentrate on financial freedom. Excess debt use may lead to a tighter future. 
Remove options that allow you to make impulse purchases. Set up a barrier that stops you from cheating on your budget. 
Irrespective of efforts dedicated to budgeting, it is difficult to predict fund requirements at each stage in life. Schedule a periodic budget evaluation to measure progress and tweak it if required. At each point, align your budget and long-term financial goals. 
Learn about financial management and investing and educate yourself to handle your finances effectively.


Ways to Budget When You're Broke

Regardless of various precautions and planning, you may suffer from increasing bills and a lack of funds. In such dire situations, the below steps may help you with your finances:

Avoid Immediate Disaster
Don't hesitate to request extensions and payment plans from your creditors. To avoid an immediate disaster, apply for an extended credit facility. Delaying or defaulting payments increases financial costs through late fees and penalties. Additionally, it also impacts your credit score and creditworthiness. 

Prioritize Payments
Analyze all your outstanding payments and prioritize them based on the due date. Chalk out a payment plan in line with your paydays and payment schedule.

You may also want to catch up if some of your bills are already due. In this case, reach out to the billing company and understand if partial payment can get you back on track toward a positive status. Tell them that you are adopting strict austerity measures to catch up. It is essential to be honest and put together realistic commitments. 

Reduce Savings
Most individuals follow the 10% savings rule, i.e., to set aside 10% of their recurring income towards savings. However, you may reduce or eliminate the savings in desperate situations. Earmarking 10% of your savings for savings is worthless if you live paycheck to paycheck, especially if you are warding off debt collectors. Savings will take a setback till you attain financial stability. 

Review Spending
Review your spending thoroughly and get a handle on frivolous expenses. Divide your expenses into essential and non-essential expenses. Similarly, you may cut down on discretionary spending and reduce excessive spending. 

Online banking and budgeting software help to categorize spending so that you can adjust expenses accordingly.

Eliminate Unnecessary Expenses
Once you analyze your expenses, it's time to tighten up. Initially, cut back on items you may not miss or habit you need to change anyway. For example, preparing home-cooked meals instead of takeout or dining in a restaurant.  

While you may not cut back on some expenses, you can reduce the quantum of spending. For instance, you may reduce spending on auto insurance by switching the service provider. 

Renegotiating Rates
Another means to reduce expenses is to renegotiate interest rates, late fees, and penalties. The belief interest rate on a credit card is set in stone is incorrect. You may ask the credit card company for a rate reduction, especially if you have a good credit history. While rate reduction will not impact outstanding, it will slow down the increase in outstanding. 

Other Income Sources
An alternative to reducing expenses is to increase your income. Consider working overtime, getting a second job, or doing freelance work to earn a secondary income. The primary purpose of budgeting is not to cut down your expenses. Rather, it is a way to manage your finances better and create a future – richer than your present. 

Budget Journal
In addition to following the steps mentioned above, monitoring progress for a few months is important. You may note down all you spend in a notebook or use budgeting apps on your phone or software to review spending. 

Measuring how much you track versus how you track your money is important. Ensure that your account for each penny by dividing your expenses into categories. Fine-tune and adjust spending as needed after each month.


Bottom Line

For individuals, a budget is extremely useful not only for the short-term but also over the long-term horizon. Corporate budgets are also essential to operate at the highest efficiency levels. Lastly, Central and State Governments also release a budget for each financial year. 

Budgeting is a concept that is alien to most millennials. However, it is a healthy financial practice, and experts recommend every type of entity to teach budgeting to set goals, measure outcomes, and plan for contingencies.


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Frequently Asked Questions

You may start by calculating your net income for each month. Next, list your monthly expenses and bifurcate them into fixed and variable expenses. Compare the difference between your estimated income and expense and adjust accordingly.

A good budget is a realistic financial plan, carefully thought out and sustainable. It must include some amount of saving for contingencies and an emergency fund. It must also include a provision to build assets for the future. Assets may include a retirement plan, funds for children's education, etc.