Budgets - The Finer Points
In the budgeting post I said that there were a few important things I would come back to later. So here we are!
- Variance analysis
- Annual expenses
- Seasonal variation
- SURPRISES!
These are the items that will lay all your good efforts to waste if they aren’t controlled.
So to recap, you made a list of the following:
- Income
- Expenses: fixed, variable, and blended (like utilities and groceries–you need electricity, that’s fixed, you can leave all the lights on when you leave home, that’s variable; you have to eat, that’s fixed, you don’t have to eat gourmet every night, that’s variable).
- You totaled your expenses and compared that to your income.
- You got either a positive or a negative number.
- You looked first at all the variable expenses for items to cut or reduce until you get a positive number.
- You went to the kitchen for a much needed glass of wine and decided that scotch was more appropriate to the situation.
- You reflected on the price of scotch and swore to buy only wine in a box from now on (variable expense!).
- You tracked your expenses diligently for a month, discovered that you were spending half your income at Starbucks, and realized that if you switched from grande cappuccinos to drip coffee you would be able to afford the scotch after all.
- You got a much deserved and long overdue raise at work, which miraculously allowed your budget to balance, and because you are so wise and have done so much work, rather than running out to upgrade your gym membership and switch to premium scotch, you kept your expenses at the same level, thus leading to an abundantly stress-free life with a balanced budget.
Do you remember the game of Life? I always hated that game. However I no longer suck at Monopoly, I can beat the pants off my pre-teen niece every time.
It seems like all the bases are covered here, right? Not quite. Let’s take them in order.
Variance Analysis
I took a budgeting class once (got an A, thank you very much). The instructor said that even in companies, variance analysis is the most frequently neglected part of budgeting. What is it? What does it mean?
Working the budget is more than simply making the budget. It is also tracking performance against the budget. Simply, once you have a budget in place, you need to track the actual income and expenditures to see how closely you are sticking to the budget. This will highlight any wrong assumptions and alert you if you are straying from your path.
As you did in the first month, you need to keep tracking all expenses until the budget and your spending behavior are so well aligned that it’s second nature. It may sound like a chore, but the payoff in stress reduction is more than worth it.
Total your expenditures by category and compare that figure to what you had budgeted. Divide the actual by the projected and multiply by 100 to get a percentage.
For example:
If you had budgeted $500 for groceries and you actually spent $650, you get 130%. That means you spent 30% over your grocery budget. That is your variance.
There are two actions you can take with that knowledge:
- Accept that your spending was not excessive and you don’t want to cut more from that budget item, in which case you need to decide to cut the overage from a different budget item.
- Reduce spending in that category.
What is not an option is to ignore the overage even though it ruined your bottom line. That will put you in a negative cash flow situation. Budgets don’t work without variance analysis.
Annual (or quarterly) expenses
This is a real killer, but it doesn’t have to be. When you make a budget, the tendency is to think only of the expenses that come up every month. A perfectly balanced budget can be decimated by regular non-monthly expenses. Make a list of everything that comes up regularly outside of the monthly budget. Here are some suggestions of things to think about:
- Memberships and dues
- Car registration
- Insurance payments
- Travel
- Back to school expenses
- Clothes and shoes (especially seasonal clothes)
- Holiday spending
Use actual numbers where you can, and make estimates for the rest. Add 10% to that number to create a cushion. Divide the total by 12 months. That number needs to become a line item in your monthly budget. Review what I wrote about cash flow and determine when the expenses are going to come up. Decide whether you will have the amount saved by the time you need it.
Honestly, this is one of the hardest parts of making the budget work. It requires discipline, and it requires a place to put that money where you won’t touch it. If you’re having trouble balancing the monthly budget to start with, this is going to be tough, but it has to be done. This is closely related to the next two topics.
Seasonal Variation
Some expenses may vary over the course of a year. Heating and cooling expenses fall into this category, also the cost of gas, and in these times, I would budget for groceries to keep increasing. This can be dealt with in two ways:
- Gather up your actual numbers for the past year, often you can do this online. Find the monthly average. In the months when your actual expense is lower than the average, set aside the difference.
- Budget the higher number, especially where there is uncertainty, as in the case of prices you can’t control (food, gas). In a good month when you spend less, set aside the difference to cover a not so good month.
This brings us to the last category…
Surprises!
Good or bad, they aren’t usually in the budget. Financial independence means the ability to respond to changing circumstances, to take advantage of opportunity, to respond to adversity.
Again, this is the part that is very hard to do if you’re just trying to balance from month to month and create positive cash flow. Nonetheless, this is absolutely essential. Create an emergency fund.
In your monthly budget, there absolutely must be a line item for savings. News flash here, all the financial mechanisms that provided for our grandparents retirement have been dismantled. Our parents are in between, maybe with some pension, some retirement plan, but in most cases, a huge gap between what was structured in to their compensation and what they actually need. For us now? We’re on our own.
Even if it’s hard to look ahead to retirement, surprises come up. Financial peace of mind requires savings equal to 3-6 months of expenses. Start slow, but start. Even if it’s ten dollars at a time, create the habit of paying yourself, set the money aside in a safe, liquid, interest bearing account that can be accessed easily in case of emergency. Do not touch it.
And once again, if every month is an emergency, then acknowledge that and start restructuring. And lay off the scotch.
Picture the future you want and start now. Good luck!
