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How to improve your cash flow - budgeting basics

With the economic context tightening, many of us are looking to improve our cash flows and save more. This is where a budget fits in. By keeping a budget and tracking our expenses we can identify areas where we can save our hard earned cash. Here's all you need to know about budgeting.

What is a budget?

A budget is a tool that helps you track your income and expenses and to plan your savings. It is a road map that helps you navigate your finances by revealing where your money is going.

A well planned budget will enable you to identify areas where you are spending excessively. Accordingly, you can alter your consumption habits. A budget will also help you identify your surplus income. Accordingly, you can adjust your savings habits. A recurring surplus will also give you the ability and the confidence to keep upgrading your family's lifestyle through better affordability of goods (TV, refrigerator, car, furniture etc.) and services (holidays, restaurants, doctors etc.).

Remember, most people get rich and stay rich not by living beyond their means but by investing their surplus income wisely. Each one of us consumes and saves. Therefore, budgeting is an activity that should be done by everyone, irrespective of age and financial status.

I am not convinced...tell me why should I keep a budget?

• Aids in planning expenditure and meeting both present and future financial goals
• Helps plan for situations where you are spending more than you earn - how to manage the shortfall
• Helps in prioritizing expenses and identifying areas where you can cut expenses
• Enables planning for major purchases, like say a car or an air-conditioner
• Assists in monitoring your debt spending like through credit cards

Can this wait, or do I have to do this exercise frequently?

A budget should ideally be prepared annually once you have an understanding of your expected income for the year so that you have a view of your cash-flow situation over an extended period of time. This will especially help you when you are thinking about purchasing big-ticket items like a car or a house.

You should also create a monthly budget so that you can closely track your actual spending against that budget on a regular basis. If you find that you are overshooting the budget in some areas you can immediately take measures to reduce your expenses in those areas or compensate by being more disciplined in others.

You need to plan for essential recurring expenses on a monthly basis (like food, transport, rent, school fees, utility bills, loan EMIs), and also budget for some discretionary expenses based on your desires and unpredictable needs (like holidays, restaurants, movies, clothes)

Itemize your sources of Income

Itemize your income from all sources such as salary, expected bonus income, investment income, rental income and pension income. Some of these items might occur only annually, so you might need to estimate the monthly figure (for example, divide the annual bonus income figure by 12).

Estimate your Expenses

Categorize your expenses under common heads. One way of doing this is through the classification of fixed expenses that you must incur (like food and rent) vs. variable or discretionary expenses (like entertainment).

A typical budget should incorporate the following expenses:

Do I have a surplus or a deficit?

Calculate the difference between your income and expenses. If this is a positive figure, you have a surplus and you can use this towards savings and investments. If this is a negative figure, identify where you might be overspending and what can you cut down on. A negative figure every month indicates that you are spending more than you can afford. As a result, you might need to borrow from a bank to support your lifestyle.

At the end of each month always compare the actual figures with the budgeted ones to see where the variance is and whether it is justified and affordable or not. An occasional variance might be acceptable. A recurring variance, which is a shortfall, might suggest that you will have some financial trouble going ahead.

Help! I have a shortfall!

Sometimes we all spend beyond our means. This results in a budget shortfall, i.e., our expenses are higher than our income. When this is a recurring problem every month, then this is the sign of a much bigger problem that will need to be fixed. If you ignore this, you are setting yourself up for financial failure.

In the short run, we might address a shortfall by taking a personal loan from a bank, or by growing the balance outstanding on our credit cards or by borrowing from a family member who is willing to lend to us. However, these are only temporary solutions because ultimately we will have to pay the money back. The bottom line is that if we are not earning more than we are spending then even paying this loan back is going to be a problem.

In the longer run, the problem needs a much deeper solution. We will need to take a detailed look at what are essential expenditures and what are purely discretionary that we might be willing to cut down on to release some more cash.

Give me more...I want to make the most of my budget?

A budget is only of use if you are diligently recording your expenses against the budget and reviewing it regularly. Otherwise, like a broken New Year's Resolution the discipline of keeping a budget can also break down very quickly. Review your budget periodically. Based on the budget you can find out if you need to increase your sources of income by taking a second job. You can decide which expenses are unnecessary and can be cut down.

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