Managing Expenses With A Budget
Create A Personal Budget
In a previous article we talked about how you can organise your expenses into different categories so that you can see exactly where your money is going.
In this article we are going to continue analysing your expenses by breaking them down further into fixed expenses, variable expenses, non-discretionary expenses and discretionary expenses.
Although this may sound complicated it’s not, and once you get the hang of it you will be in a much better position to control your budget and see where you can cut back on certain expenses.
Fixed Expenses
Fixed expenses are expenses which cost you a certain amount of money (usually each month) and will not change or change by very much.
Some examples of fixed expenses could include :
• Rent
• Car payments
• Club memberships
• Mortgage
• Loan repayments
Although fixed expenses are things you have to pay on a regular basis, this does not mean you cannot control how much you spend on them.
For example, if you are paying a higher rent than you can afford, you can reduce this fixed expense by finding another house or flat with a cheaper rent.
Or if your club memberships are eating up a lot of your money, then you could either find another club with a cheaper membership or quit the club altogether.
So even though this category is called your fixed expenses, always keep in mind that in most cases you will have the option to reduce these expenses should you so desire.
Variable Expenses
Variable expenses are things you buy on a regular basis, but do not have a fixed price.
Some examples of variable expenses could include
• Food Bills
• Utility Bills
• Entertainment
• Holidays
Generally you will find it a lot easier to cut down on your variable expenses than you will on your fixed expenses.
For example, you can reduce your food bills by cooking your own food instead of eating out, or you can reduce your utility bills by using less gas or electricity.
After you have divided your expenses into fixed and variable expenses, you can then further subdivide them into discretionary or non-discretionary expenses.
Non-Discretionary Expenses
Non-discretionary expenses are things you must pay for or buy. Some examples could include:
• Food
• Rent / Mortgage
• Car Payments
• Utilities
These are all costs which cannot be avoided. You may however be able to manage how much they will cost you.
Discretionary Expenses
Discretionary expenses are things which are not essential for survival, and can include:
• Holidays
• Entertainment
• Club memberships
If you are trying to cut back on your expenses this is a good place to start, as nothing in this category is essential for your survival and so you could do without if needed.
Knowing Your Expenses
Each of your expenses can fit into both categories to give you a better idea of how you can control them.
For example, paying rent would be classified as both a fixed and non-discretionary expense, because there is a certain amount of money which you have to pay each month.
Food would be classified as a variable non-discretionary expense, because although you have to buy food you have the option of what and how much to buy.
Entertainment would be classified as a variable discretionary expense, because you have the option of whether or not to spend your money on entertainment and how much you spend.
If you are trying to cut back on your overall expenses, then it is a good idea to start with variable discretionary expenses and then move your way up to the fixed non-discretionary expenses.
Spending Ratios
One helpful way to determine where you need to cut expenses is with spending ratios.
A spending ratio is simply a percentage of your total income that you use for a particular area such as housing or transportation.
If one area of expense becomes too great, you will be able to see that ratio is too high and cut back on your spending.
To figure out your spending ratio for a certain category use the following steps :
• Pick a category to work with, such as entertainment. This will now be called your entertainment payment ratio.
• Add up all your entertainment related costs for one month.
• Divide your total entertainment costs by your total income for that month.
• The percentage you are left with is your entertainment payment ratio.
Here is a quick example to demonstrate this :
• You earn £400 each month.
• You spend £100 on entertainment each month.
• 100 / 400 = 0.25
• Entertainment spending ratio = 25%
You spend 25% of your monthly income on entertainment, leaving you with 75% for other things.
As a general rule, if you get a spending ratio of 30-40% or higher you should think about cutting back on expenses in that area.
There is one exception to this, and that is your savings ratio. Your savings ratio is the amount of money that you save, and ideally should be as high as possible (at least 10%).
When creating your budget the idea is to work out how much income you have each month, and then divide that income to meet all your expenses.
Ideally you should also be working on ways to reduce your expenses in each category, so that you can devote more of your budget from one area to another.
So if you decide that you want to reduce your expenses in the entertainment category from 25% to 12.5% (half your entertainment costs), you will have an extra £50 in your budget for other expenses such as savings.
Whatever spending ratios you decide upon, just remember that by sticking to them you will always have control over your finances because you will not be able to spend more than you can afford.
Your Financial Lifestyle
Once you have decided on the amount of money that you have coming in (gross income) and all the money that you will have going out (expenses), take a look at your current financial situation to see how you are doing.
If you find that you are able to pay your bills on time, save a portion of your income and still have some money left over for discretionary purposes then you are in a very good financial situation and should keep it up.
If however you find that you are spending everything you earn and not saving anything, or spending more than you earn and getting yourself into debt, then you need to take immediate action to remedy your financial situation because if you don’t act now it will only get worse.
There are two main ways in which you can deal with a bad financial situation: spend less or earn more. If you are in a really bad situation, you may have to do both.
Some people may not like to spend less because they enjoy purchasing things, so if this describes you, then unless you are able to earn some extra money your financial lifestyle will probably get you into debt if it hasn’t already. The only real way to earn extra money is to get a second job.
If you do decide to get a second job, be careful of what you do with your money. As if you are used to spending lots, then earning more will only encourage you to spend more which will not help your financial situation.
Stick to Your Budget
The way you spend and save your money today is a result of the things you repeatedly did in the past.
In others words, your financial situation is a result of your financial habits and the only way to change that situation is by changing your habits.
Creating and sticking to a budget can help you do this, however don’t expect it to be easy as old habits tend to be quite hard to break.
But once you do manage to change your financial habits, you will find that your financial situation will also quickly change.
So do the best you can and try to learn from your budget so that you can spot trends in your spending.
You may discover that you are spending far more money on something than you realised, and by stopping it, or finding an alternative, you could dramatically cut down on your expenses.
How you choose to create your budget is up to you. Some people prefer a notebook and pen, whilst others prefer computer money managing software such as Microsoft Money or Quicken.
But it really doesn’t matter what you use, as long as you use something that you are comfortable with and will stick with in the long run.
Good luck creating your budget!
