Budgeting and Cash Flow
Building the Budget and Putting it All Together
Okay, how do I actually build my budget? The first stage is to list all of your income sources. This includes all jobs, gigs, businesses, government grants, investment income or pension income. If there are sources of income that are not likely to be repeated, list them for now but keep in mind that they may not be there for future budgets. Government money like HST credits or Trillium benefits can also be added. This can be done on paper, in a spreadsheet, in an app or in a program like Quickbooks. Programs designed for businesses can be used for budgets as well because you can structure your budget like a business. The revenues are the same as income and the expenses can be business or personal expenses. The big picture equation is below.
Income From All Sources (Employment, Entrepreneur and Investment)
Subtract Mandatory Deductions
Subtract Voluntary or Optional Deductions
Subtract Fixed Expenses
Subtract Discretionary or Variable Expenses
Equals My Budget Balance
A Positive budget balance means that I have money left unallocated for this period – savings. A negative budget balance means that I need money to cover what I want to allocate this period – I will have to dip into my savings or go into debt. A zero budget balance means that all of my money has been allocated somewhere.
Once you have these items listed, list your mandatory deductions as per the paragraphs above. Include taxes deducted on pay stubs or installments being paid to the CRA throughout the year. Taxes may have to get adjusted at the end of the budget depending on what is happening on your tax return. You can use this stage to add HST collected or expensed as a self-employed person. Subtract these items from your income sources to arrive at income after mandatory deductions.
Now, make a list of any optional deductions such as RRSP contributions, TFSA contributions, RESP contributions, automatic savings plans or profit sharing incentives. These are voluntary allocations that tend to happen each year. If you do lump sum contributions each year, list these as well. Subtract these amounts from your subtotal to arrive at income after voluntary deductions. Lump sum mortgage or debt payments can also be listed here since these can be changed in a given year.
The next stage of the calculation is the fixed expenses. These are items that persist over multiple years and can be changed but typically over a period of time. These are also items tied to life’s big decisions, like where am I living, what car am I driving, and how am I paying for big ticket items. Examples include rent, mortgage, continuing debt payments each month, car lease payments, day care expenses, tuition fees for a multiple year degree or diploma, utilities and insurance payments of all kinds. If you have a business and have fixed expenses for your business, this would be the stage to include these expenses. Examples include rent for commercial space, utilities used for the business, web site costs, or business automobiles. Since all of the money is part of your budget from personal and business, the personal and business aspects are listed separately but then are merged together to see where all of the money is going. You will now have income after fixed expenses.
The last stage of items is the discretionary expenses. This includes anything else that you would spend money on like food, entertainment, clothing, children’s needs, gifts, holiday spending, electronics, household goods, landscaping, medical, hygiene, donations, travel and hobbies. Make a list of categories that describes where your money is being spent so that you can easily see where the money is going. The number of categories can vary as long as you have a decent picture at a glance of how much is being allocated to what category. Use categories that best describe your lifestyle as opposed to generic categories. For example, if you have children, you can have day care, camps, toys, children’s entertainment, and so on. If you are a small business owner, you would have more business expense categories. If you are retired, there may be more expenses for various hobbies, grandchildren and leisure. The budget will be custom made for your lifestyle and your situation. The sample below is generic to give you an idea how the budget can look.
Notice that expenses can vary be month and by season, particularly holiday spending, seasonal hobbies and items like landscaping or travel. Note also that most of the budget can be done in a few hours. The mandatory, optional and fixed expenses do not vary much so once they are known, they can be looked at once per year. Most of the focus and work when it comes to budgeting is on the discretionary expenses. There would be more to consider when there is a big decision to make and many aspects of the budget can change.
How Much Detail Do I Need?
How do I total up the discretionary spending items because there are so many of them? There are many methods you can use – you can write everything on paper and summarize each week or month, look at credit or debit card statements an categorize them, download expenses into a spreadsheet if possible, use an app like Mint, or feed receipts into a Quickbooks-like software program. I don’t find any method to be fool proof because people typically buy things with cash, credit and debit so you would have to account for all of the methods. Spending can be tracked as money is spent or done periodically like weekly or monthly. I wouldn’t update every year because you will forget what you spent your money on after a period of time.
Do I need to track every dollar that I spend? The answer to this question is no. If you are off a few hundred dollars each year, it likely will not be noticed. If your budget is very tight, a few hundred dollars may make a difference so track until you have a good idea where the money is and can make accurate decisions. Be mindful of frequent small amounts that add up to large expenditures at the end of the year. If you have heard of the “latte factor,” this is what it is referring to. If I spend a dollar a day on a coffee, I would spend $365 per year. Is this important? It might be. If I do this for 10 different items, I now have $3650 spent per year. This can make or break a budget. Does this mean you should not have these expenditures? This will depend on what value you are getting from the expenditures and how you are making your budgeting decisions. This will be discussed more in the psychology section.
A sample budget is provided below which has a bit of everything in terms of income and expenses so you can see how it fits together.