By: Hirsch Serman, MBA, CPA
Let’s pretend! You the CEO of a company called Me, Inc. and you have income, taxes, expenses, some employees (kids, spouse etc.) and other obligations. In reality, that is exactly what a family is from a financial standpoint. Firstly, congratulation on the promotion to CEO. Secondly, is your company profitable?
There is an old adage that if you fail to plan, you plan to fail. Creating a budget helps you take control of your financial wellness, get a better grasp of your money, and learn how to manage your money better. No matter how you track your budget (apps, websites, spreadsheets), it is important to understand your cash flow. You have money coming in (usually the easy part to identify) and money going out (and it seems to go far to quickly and to too many places besides your bank account). Having a realistic budget helps you plan for financial goals (vacations, college, retirement and more) as well as have more control over your finances. Having financial goals and working towards these goals through a budget increases your likelihood of meeting your future needs. The key is learning to monitor your finances in a realistic manner that works for you. This may sound daunting in the beginning, however, it becomes easier as you do it. No matter your reason (I am sure they are all good reasons) you want to create a realistic budget, you can follow these steps to get started:
Step 1: Know how much money is coming in, NOT your income
In many people’s minds their income is what they can use to live off of (and hopefully to save). Unfortunately, this common thinking is not correct. For most people, taxes, social security, and other payroll deductions are first taken out of one’s pay check prior to receiving your money. This means if you have a salary of $100,000 that you do not have $100,000 to use. Knowing your net income (your remaining income or final take home pay after these types of deductions) is vitally important. Having an extra source of income like a hobby or side business may be helpful as well.
Step 2: Track your spending
Yes, this one is a pain to do however it is amazing how much you can learn about your spending by diligently tracking what you spend. More importantly, it empowers you to make choices that positively impact you. I was counseling someone who wanted to go on vacation with her two daughters and could not find the money to do so. When I showed her she spends roughly $2,300 a year of pre-tax earnings on coffee (in her case that’s about a cup of coffee a day) she bought a Nespresso started taking a cup of coffee to the local Starbucks.
You will have some regular recurring expenses that are the same amount every month. These are easier to budget, for instance mortgage/rent or car payments. These are often fixed payments and hard to modify unless you pay of the loan (always a good accomplishment). You may also have fixed amount expenses every month that are not necessities, for instance cable or Direct TV. The initial challenge is to learn the variable expenses that may be necessities (e.g. groceries) or may be part of living life rather than merely existing (e.g. entertainment). Often working with someone in the beginning helps keep you accountable to your plan until you are more comfortable and familiar with creating and living to a reasonable budget. I remember speaking to someone and suggested they subscribe to Netflix and Hulu (they already had a Prime account) and then to cut the cable. They still have plenty of viewing options and this comes with about $210 a month savings.
By tracking and understanding where you spend money it is easier to identify how to make adjustments and to be aware of your spending habits. You will have the ability to recognize your spending habits – healthy and not so healthy – and modify them as needed. Often slight adjustments can result in thousands of dollars in savings.
Step 3: Create a budget for each month
On the onset this sounds like duplicating your efforts. It is important to do this for a couple reason. Firstly, you may receive income or incur expenses on an irregular basis, for instance receiving a bonus at work or paying an annual premium on life insurance. Secondly, living by a reasonable budget becomes easier as you build awareness and healthy spending habits. In psychology, the latter idea is often called the Baader-Meinhof phenomenon or the frequency illusion. This is the phenomenon where one encounters an idea, action, or information that is not in the forefront of their awareness (and probably has been occurring all along). Then soon after the person encounters this same idea, action, or information repeatedly. This “new to you” concept seems to suddenly present itself to you more frequently. In our case, through the choices you can make in your purchasing of items. The more familiar you are with your budget, the less likely you are to make unnecessary impulse purchases, and possibly more importantly, will be readily identify which purchases are impulsive.
Step 4: Your scorecard
A key step is to review your actual spending for the month to the budget for that month. This helps you stay on track and to tweak your budgeting as needed moving forward. Many financial institutions have tools to help you understand how you are doing. For instance, Bank of America has a spending analysis tool (https://bettermoneyhabits.bankofamerica.com/en/saving-budgeting/spending-tool) that allows you to see how your spending measures up to others in your area. Be careful when comparing to others as this is intended to improve your financial situation and reduce the unnecessary spending (It is NOT meant to be a “keep up with the Jones’ tool). Reviewing your actual spend also allows manages changes in your budget whether you receive a raise at work or incur new expenses.
Step 5: Create healthy spending habits
At this point you should be a pro! Knowing what you have coming up financially in the next month can reduce your stress. Standing at the register and having the light bulb go off on impulsive purchases is huge. It also helps you think about ways to get the impulsive purchase at a significantly reduced price. For instance, I have spoken with people who grab a magazine as they are waiting on line to pay (and yes that is exactly why they are positioned there – to sucker you in). Often you can get an entire year’s subscription for the cost of 2 – 3 magazines taken of the counter. Changing a habit can be tough. It may help to work with someone for a short time to objectively review your spending with you. Once you start, it often becomes the motivation to look for more ways to create financial wellness.
Hirsch Serman, MBA, CPA is the founder of Lifecycle Financial, a company that helps those going through Divorce and other life cycle changes to navigate the financial pitfalls of a new life dynamic. The company was founded through personal experiences in divorce and watching the changes in an aging parent. He has worked in finance for over 20 years (including financial planning and tax) and has taught on the university level as well as conducted seminars for high school youth on personal finances. Hirsch is a member of the American Association of Daily Money Managers (AADMM).
INC., The Memphis Business Journal, The New Southern, and Funding Sage media outlets have all covered his work in Divorce and Hirsch was selected to be a New Orleans Entrepreneur Week Fellow. Hirsch has a passion to serve others and has worked with numerous non-profit boards including the United Way and is a trustee of Texas College. Please reach out with any comments to [email protected].