What is a Budget?

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Definition:

A budget is an estimate of how much money you expect to receive as revenue, and plan to use for expenses, over a given period of time.

🤔 Understanding budgets

A budget is a formal statement detailing projected expenses for a given time period and the sources of income that will finance those expenses. Budgets are useful tools for individuals, companies, and governments to coordinate their resources and expenditures. While budgets may not be legally required for companies in the private sector, most owners and managers often create them for financial planning and other purposes (like setting goals, measuring performance, and contingency planning). A budget can show whether your forecasted expenses equal your total revenue (aka a balanced budget), exceed revenue (a budget deficit), or fall below revenue (a budget surplus). You can develop a budget for the short term (like a week, month, or quarter) or the long term (think a year or more).

Example

The State of Hawaii originally budgeted a total of over $14.4B in expenses for the fiscal year 2018-2019, which started on July 1, 2018 and ended on June 30, 2019. However, the state actually spent about $12.2B in that period, approximately $2.2B (or 15%) less than originally budgeted. In that fiscal year, the State of Hawaii was able to spend less than it had budgeted, resulting in a budget surplus.

Takeaway

Using a budget is like using a shopping list at the grocery store…

A shopping list helps you shop efficiently and save time. However, it’s also just a plan. Once you’re at the grocery and start shopping, you may find a better deal than expected, make an impulse purchase not on your list, or find that an item on the list is out of stock. After completing your grocery run, you’ll get a final receipt and be able to compare your planned and actual expenses.

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What is a budget?

A budget is like a financial plan in that it lays out a series of expenses over a period of time, and indicates the sources of revenue providing funding for those expenses. From federal governments to individuals, anyone can set up a budget to plan how they’ll allocate money during a given period (like a month, semester, or year). A budget can help keep track of where the money is going, reconcile planned expenses with actual ones, and provide data to adjust or improve a budget better in the future.

Most budgets have three main components: revenues, expenses, and differences between budgeted and actual amounts.

  1. Revenue: This is the total income that is available for the given period. Companies generate revenue through sales of products and services; governments mainly do so through taxes, and individuals through paid work or other income sources.
  2. Expense: This is the amount of money spent on different services or products. A company often needs to pay for expenses in order to generate revenue. For an individual, an expense (like rent, groceries, etc.) may be a necessary cost of living.
  3. Difference between budgeted and actual amount: At the end of a budget period, subtracting actual spending from budgeted spending reveals whether you were:-On budget: Actual spending = Budgeted spending -Over budget: Actual > Budgeted -Under budget: Actual < Budgeted

Example of a budget

Let’s imagine that you’re a student budgeting for expenses during one semester at a four-year public university, where you pay in-state tuition. Here’s how a budget might help with financial planning.

Below is an example of what an original budget might look like for one semester — It shows that you’re planning to cover a total of $12,645 worth of expenses with $13,000 of income.

Expense Amount
Income
Part time job$6,000
Bursary$5,000
Student loan$2,000
Total Income$13,000
Expenses
Tuition$4,985
Room & board$5,400
Books & supplies$625
Transportation$585
Other expenses$1,050
Total Expenses$12,645

And here’s an example of what the actual expenses might look like at the end of the semester, compared to the amounts budgeted.

Semester at a Public Four-Year College (In-state Tuition)
BudgetedActualDifference (Budgeted - Actual)
Income
Part time job$6,000$5,500-$500
Bursary$5,000$5,0000
Student loan$2,000$2,0000
Total Income$13,000$12,500-$500
Expenses
Tutition$4,985$4,9850
Room & board$5,400$5,4000
Books & supplies$625$6250
Transportation$585$500-$85
Other expenses$1,050$1,200+$150
Total Expenses$12,645$12,710+$65

Here’s how you might read this budget. In this example, your actual expenses were $65 higher than you planned, mainly due to an increase in “other expenses.” Additionally, you were not able to work as many hours as planned and earned $500 less from the part-time job. And while you did cut back on transportation expenses, in the end, your total actual expenses exceeded your total actual income by $210.

This data can be useful in revealing things like spending habits, or that you may need to pay closer attention to your discretionary spending (such as non-essential or unnecessary costs).

What are the different types of budgets?

There are many types of budgets. Many fall into one of two major categories: those for corporations and individuals.

Corporate budget

Budgeting is one of many skills needed to run a business. Due to the nature and legal reporting requirements of a corporation, a corporate budget (aka an operating budget) is a standard practice in business and corporate operations.

A corporate budget is typically used to achieve an objective — To articulate a goal in a measurable way and determine how to allocate available resources that can help achieve that goal. To do so, managers need to compile a lot of data from each department (for example, finance, marketing, operations, sales, etc.). Depending on the size of the corporation, a corporate budget may have many levels, based on country, region, division, and department.

Elements of a corporate budget

A typical corporate budget uses five components:

  • Revenue: Typically, a company’s budget lists all sources of revenue and details essential components that determine that revenue (think of the number of units sold for a retail operation, or the price of contracts sold for an advertising agency).
  • Variable costs: These are expenses that are tied to a company’s production or sales. The higher the level of production or sales, the higher the variable cost. For example, the more coffee a coffee retailer sells, the more cups it needs.
  • Fixed costs: Unlike a variable cost, a fixed cost is an expense that’s independent of production or sales. For example, a car rental company must pay for the electricity bills at its stores no matter how many car contracts it sells.
  • Non-cash expenses: Generally accepted accounting principles often require corporations to record expenses that were paid for through a means other than cash, like depreciation (a decrease in value of an asset over time) or amortization (spreading the cost of an intangible asset over time). Owners, analysts, creditors, and other stakeholders may include non-cash expenses in budgets to reflect expected expenses, or remove them to focus on true cash-flow.
  • Non-operating expenses: A corporation often includes expenses that are not related to operations in its budget because those expenses, such as tax and interest payments, also need to be covered to sustain operations.

What is the difference between a static vs. flexible corporate budget?

One main difference between a static corporate budget and a flexible one has to do with whether managers can adjust the budget during a given period.

  • In a static budget, a manager can’t make changes once it has been set, even if the budget’s original assumptions change due to a change in circumstances. Think of how the cost of a barrel oil might dramatically increase for an airline operator, for example, or how the Federal Reserve might implement a rate cut affecting the mortgage rate of a bank.
  • In a flexible budget, a manager can make adjustments throughout a budget period, allowing the budget to reflect changes closer to real-time.

Personal budget

A personal budget is a useful financial planning tool that can help an individual track their expenses and see how much money they need to earn to support their cost of living. A typical objective for a personal budget is to help an individual spend less than they earn, allowing them to save for things like an emergency fund or retirement. Personal budgets are often designed for a month at a time, but they can also cover a longer or shorter period of time.

Elements of a personal budget

A personal budget often includes:

  • Income: This is the money that you’d earn through your job, business, or other sources (think alimony, childcare payments, an inheritance, etc.). Income is the pool of funds that you use to cover your expenses.
  • Expenses: This typically refers to living expenses, including housing, food, housekeeping supplies, clothing, and personal care products, or and services. Depending on your situation, expenses will vary.
  • Savings: This is the pool of money you might set aside after covering your expenses. There are schools of thought about how much you should set aside for savings. For example, the 50/30/20 rule recommends saving 20% of your paycheck for things like retirement or a rainy day fund.
  • Cash Balance: This refers to the amount of your income leftover after paying for expenses. Income - Expenses - Savings = Cash Balance.

How do you create a personal budget?

A digital spreadsheet can be a helpful tool to create a personal budget because it allows you to save your work, make changes as needed, and use formulas that can automatically add or subtract numbers.

How to create a personal budget in Excel

Let’s build a monthly personal budget template using Excel to keep track of your:

  • Total monthly income
  • Total monthly expenses
  • Total monthly savings
  • Cash balance

Keep in mind that there are many different ways to set up a budget. This is just one example.

Step 1: Set up your personal budget summary

Starting on cell A1, set up two columns: one to describe the variable and one for the value. In Excel, you could set up a simple spreadsheet like this example:

AB
1Total montly income
2Total monthly expenses
3Total monthly savings
4Cash balance

Format the values for cells B1, B2, B3, and B4 as “Currency” to two decimal places. This allows you to input a round number like “100,” and have it appear as “$100.00”.

In cell B4, enter the formula =B1-B2-B3.

Step 2: Calculate your total monthly income

Then, starting on cell A6, you’d set up your “Total monthly income” and list all sources of income. Let’s assume that you have two sources of income: a full-time job, and a part-time car-sharing gig. Enter the respective amounts for each source of income on cells B7 and B8. To automatically calculate your total monthly income, in cell B1 input the formula =sum(B7:B8). (Note: To simplify calculations, the values in this example are post-tax.)

AB
1Total monthly income$3,000
2Total monthly expenses
3Total monthly savings
4Cash balance
5
6Income$3,000
7Full time job$2,500
8Car sharing gig$500

Step 3: Calculate your total monthly expenses

Starting on cell A10, set up your “Monthly expenses” and list all necessary expenses. For this example, we will assume 12 expenses, including rent, electricity, and car payments. Enter the respective amounts for each source of income, starting on cells B11 through B21, as shown below.

To automatically calculate your total monthly expenses, in cell B2, enter the formula =sum(B11:B21).

AB
1Total monthly income$3,000
2Total monthly expenses
3Total monthly savings
4Cash balance
5
6Income$3,000
7Full time job$2,500
8
9Monthly Expenses
10Rent$900
11Electricity$100
12Cell phone$50
13Groceries$600
14Car loan$150
15Car expenses$100
16Car insurance$50
17Student loans$50
18Credit cards$150
19Personal Care$100
20Entertainment$150
21Other expenses$50

Step 3: Calculate your total monthly expenses

Starting on cell A23, set up your “Monthly savings” and list your savings goals (like an emergency fund for unexpected expenses). For this example, let’s assume you’re contributing to an employer-sponsored 401(k) plan (a retirement savings account to which you may contribute directly from your paycheck) and in a savings account.

In cell B3, enter the formula =sum(B24:25).

AB
1Total monthly income$3,000
2Total monthly expenses$2,400
3Total monthly savings$300
4Cash balance
...
23Monthly Savings
24401(k) plan$200
25Savings account$100

Step 4: Automatically calculate your total cash balance at the end of the month

Since cell B4 was already set up with the formula =B1-B2-B3, your Excel template will automatically calculate that you have $300 left in cash at the end of the month, according to this example.

AB
1Total montly income$3,000
2Total monthly expenses$2,400
3Total monthly savings$300
4Cash balance$300

Why does budgeting matter?

Budgeting matters because it allows organizations and individuals to build better plans by translating actions (like how they need to earn and spend) into numbers, and using those numbers to track progress towards their goals (like saving up for a house). For example, if your goal is to save money, it may be helpful to express that goal in a more specific way. For example: “By reducing my total monthly expenses by $200, I could save $200 in my savings account at the end of the month.” Setting specific and quantified goals can help track actual progress and know how close or far you are from achieving it.

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