budgeting for dummies part 2 evaluating your budget

August 24th, 2007

Budgeting for Dummies Part 2: Evaluating Your Budget

In Part 1, we created a budget by making a list of income and expenditures and then allocating all of your income for a month into different spending or saving categories. Today we are going to evaluate that budget and see how effective it is. There are 5 main steps we are going to follow: Tracking, Assigning, Assessing, Establishing, and Applying Surpluses.

1. Keeping Track of Every Penny

The biggest part of evaluating your budget is tracking your inflows and outflows, and assigning those outflows to your budget categories. If you don’t know what you spent the money you earned on, there is no way to see if the budget is at all reasonable or effective. To do this, we need to keep track of every single penny spent and earned for an entire month. This can be done with online software, or with an excel spreadsheet, or even pen and paper. But every single penny spent must be accounted for, as well as exact figures for how much money you took in.

2. Everything you spend money on must be assigned to a category in your budget.

The easiest way to see right away if your budget is reasonable is to track what category each expense falls under as you spend it, and enter it into that category immediately. But this can be time and labor intensive, and discourage you from budgeting at all. An alternative to this is to simply designate a place to keep receipts, and faithfully get a receipt for every expense and collect them all there. Once a week, you can sit down and assign each receipt to a category and notate them there. Make sure there is a running total for each category of how much you have spent and how much is left for that month. This is much simpler if you are using some sort of spreadsheet or online-based method to keep track… or you have a *lot* of paper and a great eraser.

3. Assess, reassess, and adjust

Try as much as you can to stay within the budget you’ve established, but don’t be discouraged if you overspend a category. It is very common for some of your estimates to be off by quite a bit if you’ve never had a budget before. My first attempt at a budget allocating every dollar, I only assigned $10 to miscellaneous. I am sure any budgeting veterans reading this are now snickering, if not laughing out loud. I well overspent that category my first month. The budget is a process, and a tool to help understand where our money goes and how our priorities lie. It takes time and tweaking to make it work for you. But it can, and will work, with a little time and patience. If you do overspend a category, try to adjust another category to make up for it so that every dollar remains assigned and your outflow does not exceed your inflow. Sometimes we underestimate some categories but overestimate others, and then the adjustment is obvious. If it isn’t obvious, you may have to adjust out of your snowflaking or savings category, but only if nothing else can be cut. Try to cut small amounts from several categories vs a large amount from a single category.

4. Establish a system to keep track of money for irregular expenses

There should be line items in your budget for irregular expenses – those that don’t happen every month but you need to have money for when they come up. Ideally, you are saving 1/12th of the total for each of these expenses every month. But how do you keep track of that earmarked money? I put it into an ING savings subaccount very creatively labeled “Household Expenses”. You can keep track of the money in any matter you choose but for simplicity’s sake I wholeheartedly recommend moving it to its own account. Many people call this a “Freedom Account”. You can transfer back the money you need when the expenses come up.

5. Apply the surplus to debt, savings, or investment

If at the end of the month, you’ve underspent categories and have a surplus, assign it to a category like debt reduction, saving, or investments, depending on what life point you are at, so you can zero out the budget for the next month. Knowing how much of a surplus you have can also help with readjusting and tweaking the budget for the next month.

And there you have it, we’ve evaluated how well our budget has worked. Part 2 should take a month to complete. If you are interested in seeing how budgeting can work for you, commit to September being the month you start. Follow Part 1 and create your budget, and use September to evaluate how realistic that budget is. Near the end of September, we’ll do Part 3: Re-evaluating and Readjusting – Sticking to a budget. I’m looking forward to it!

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