We’re now on to the fourth lesson in my personal finance basics series. It’s important to know that my lessons are not necessarily in chronological order, as this lesson could have easily been one of the first steps, rather than the fourth. However, for simplicity I wanted to present key concepts (setting goals and analyzing them) in understanding the overall picture before we take a step back and break down the basics in more detail. Having said that, we are now starting at square one, the very fundamentals of personal finance, looking at your income and expenses to better understand your current financial situation.
Every week, two weeks, or month you’re paid for the work you do. This is your income for now, later you will build income from your savings and investments. It’s important to understand that this money that you’re making is limited for the time being, and you must get a handle on how much you’re bring in, versus how much you’re spending, if you ever expect to be able to save and invest. If you’re spending more than you’re bringing in you will have a very difficult time achieving any kind of financial success.
The purpose of budgeting and planning is to take control of your spending.
If you set no guidelines on how you spend, it’s hard to determine if you’re on track to meet any goals you’ve set. By laying out your income and expenses, you can see where your money is going and you can determine if you’re on the right track or not. At the beginning of the month you plan how much you will bring in in income and spend in expenses, and at the end of the month you must evaluate how well you did against what you said you were going to do.
There are several free programs on the web designed to help you set a budget and track your finances. There are also various software programs that you can pay for, that may offer more than the free versions. But for now, I would encourage you to try out a free program to limit your spending.
Most all businesses operate based upon budgets or forecasts, at least the successful ones do. You must treat your personal finances as a business does. Why? A business without forecasts or budgets would have little control over spending and it would be hard to hold anyone accountable for their spending. When a business sets their budgets or forecasts, they make assumptions based upon their current needs versus their future needs for cash. In other words, they only make so much money, if they don’t balance their current needs against their future needs, they will be challenged to grow their business because they won’t have the money to expand. Just like you, if you only concern yourself with what you need now, you probably won’t have anything for later.
With a budget or forecast in place, the business owner can evaluate how well they did, and if there is overspending in certain areas, they can take corrective measures to ensure it doesn’t happen again. Without this, it would be much harder for them to determine what even went wrong. At the same time, if they see areas where they underspent, they can reevaluate their needs and see if they can decrease their budgeted spending in certain areas. The idea is to make realistic yet challenging budgets. The same is true for you.
In your budgeted expenses you must build in to account your need for saving for the future, so you can grow your money to one day work for you. Otherwise, you will be trapped into working for money for the rest of your life.
This all sounds much more difficult than it really is, the bottom line is you want to hold yourself accountable for your spending, to make certain that when you spend it truly is a complete necessity. You may be scared to do this, but you shouldn’t be, this is the first step to making a great change in your life. Don’t be worried that you will no longer be able to have fun, I will show you soon how to learn how to be much happier without spending a dime in most cases.
My next lesson will take a deeper look at setting up a budget for yourself, so we can make better sense by actually seeing what I’m talking about above.