Importance & Roles of a Budget

A budget is a roadmap to financial security. You wouldn't even think about starting out on a cross country vacation without loading your GPS or at least taking a look at a road atlas. Your finances are not that different. Just like with a road trip, you need to know where you are starting from, where you want to end up and how you are going to get there. A budget gives you the essentials you need to get from point A to point B, regardless of whether you want to take the scenic route or the fastest path.

A budget can help you manage your cash flow. A cash flow statement is an integral part of your budget, and it's easy to create. Just add up your regularly monthly income from all sources, including your salary, interest on savings and investment income, then subtract all of your regular monthly expenses, such as housing, food, gas, and debt payments. Whatever is left over is your discretionary income. If the result is a negative number, you are adding to your debt load every month. The cash flow portion of your budget will let you know if you need to cut expenses, increase savings or maybe even if you need to get a new job that pays more. While the money you have in savings is not part of your discretionary income, you might need to use it to reduce your debt.

If you haven't been living on a budget for a while, you probably don't really know where all of your money goes each month. It will help to keep a spending diary for a month to six weeks to track your expenses. You might be surprised to find out how much you're paying per month for that daily morning latte or how much that slight bump in gas prices set you back. The spending diary portion of your budget will help you determine where to allocate your money and where you need to adjust your spending habits.

Creating a household budget isn't rocket science, but it does take a bit of time and effort. There are two things that can absolutely kill a budget's effectiveness: "garbage in" and "garbage out." "Garbage in" in this instance means creating your budget using erroneous or unrealistic information. If your take-home pay is $3,500 but your budget adds up to $4,000 for the month, it will not work over the long haul. Eventually you will run out of borrowing power. "Garbage out" is when your budget is valid and meets all your needs for each category, but you fail to abide by it either intentionally or accidentally by overspending. For example, if you budget $400 for clothing, but spend $600, your budget will fail. It's not that your budget was wrong, you simply spent more than you had available for that category.

Chances are your budget won't work the first month you try it. That's okay. A budget is a work in progress, not a rigid taskmaster. You might need to go through the process for several months, making adjustments along the way until you get it right. Even after you get your budget established, you'll probably need to revisit it periodically when you have life changes.