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What Is Budgeting

Budgeting is the process of ensuring that over time, the amount of money you spend is not more than the amount of money you earn. In shorter time frames it is possible to spend more than you can earn, but over the long term, proper budgeting will plan and achieve a situation where all money spent, will be paid for by money earned.

 

Budgeting is important for all legal and financial entities, as we all must at some stage, pay for what we have spent. It does not matter if we are a "person", like you and me, a business, or even a government, this fact holds. There is one word that describes the financial entity that, over time cannot pay for its spending...BANKRUPT

 

There are 2 basic approaches you can try when developing a budgeting discipline. The first approach is favored by my partner and I call it Budgeting By Constraints. I'm more of a fan of the second approach, which I like to call, Budgeting Beyond Constraints. Both are perfectly valid, both achieve the same thing, which is, ensuring over time we earn at least as much as we spend

 

Budgeting By Contraints

Budgeting by constraint is recognising there is an upper limit to the income you will earn. In recognition of that limit, you plan not to spend more than it.

 

To begin, you must define how much the income you have is at your disposal. You do this by deducting your tax obligations from your gross income. From there you need to deduct all other absolute and existing commitments. For a business, this would include things like wages, office rent and suppliers. For a person, this would include things like food, rent or mortgage and utility bills. Interest payments on any existing debts also fall into this category.

 

Once you have deducted all these things from your original income amount, you are left with your remaining disposable income. This is the money you have left to spend.

 

From this point, you must look at all the things you want to spend your money on and prioritise them. Then you buy the item at the top of your list, and keep doing so until you run out of disposable income. When you run out of disposable income, you have hit your budgetary constraint. .

 

If you want to bring purchases forward, and buy them before you earn the money, you can do this by borrowing. But remember, by borrowing to spend today, the repayments and interest on that borrowing will reduce your disposable income tomorrow.

 

Budgeting by constraint plans that over time, your income pays for all the things you bought. This includes paying off interest and debts acquired along the way, which should always be part of the budgeting plan.

 

Budgeting Beyond Constraints

Budgeting beyond constraints is similar to the above, albeit flipped upside down. Budgeting beyond constraints means you start with the list of things you want to spend your money on and then work out how to earn enough money to pay for them, when and as payment falls due.

 

When planning how much to earn, calculating tax becomes very important. You can't plan out $50,000 worth of purchases by planning $50,000 worth of income. If you do, when you get your tax bill, everything will fall down around your ears. Rather, you need to treat tax as one of the items you are going to spend money on, that you need to generate extra income to pay for.

 

This method of budgeting is fraught with pitfalls and dangers though. To start with, it assumes the financial entity does not have an income constraint. For example, this would not work for a salaried or waged employee of a company. It also assumes an unlimited upside to income generating potential, which is not a reality for most of us.

 

The one reason I prefer this method of budgeting is that it is inspiring, it encourages us to reach further, than just for what is right in front of us. It lends hope that we can achieve and possess the things tomorrow, which are out of reach today and it gives us the motivation to keep at it, until we do achieve those goals.

Budgeting and Investing

There is no right or wrong way to budget. Ultimately all you need to do is find a way to "balance your books" over time. Investing can play a big part of this. If you budget using a method that works for you, and ensure you have money left over in the short term, you can then use that money in big earning investments such as our high yield investment strategies. Such a budgeting technique will then increase the money you are earning, and therefore your disposable income.

 

The beauty of budgeting and investing is that the income your investments make, is bonus income over your already established budgeted income. In the short term you just don't need it, as it is not in your budget. So it is easy to do little things like only include half the investment income in your new income limit. That way you get a little bit more to spend as our reward, and your investments keep growing, so you continue to earn more income. Its not hard to see how such a simple technique could quickly have a major impact on your life.

 

 

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