Budget

A budget is a plan that sets out how much money a person, household, business or government expects to receive over a period and how that money will be spent, saved or used to repay debt. Households use budgets to make sure income covers bills and goals; companies use them to allocate resources and measure performance; governments use them to authorise spending and taxation.

A budget looks forward, while accounts and statements look back. It is closely tied to cash flow, the actual timing of money in and out, and to expenses, the costs the plan has to cover. Because money is limited, every budget is an exercise in scarcity and choice. A national government budget follows the same logic at a much larger scale, with a legislature voting on the plan.

Think of a budget as a packing list for a long trip with one suitcase. Before leaving, you decide what goes in and what stays home, because the case only holds so much. If you add a heavy coat, something else has to come out. A budget does the same with a monthly pay cheque: it lists what must fit (rent, food, transport), what would be nice (meals out, a holiday fund) and what is set aside for later.

The value comes from deciding in advance rather than at the till. Without a plan, money tends to leak away on small purchases and the month ends before the pay does. With one, a person can see early when something will not fit and make a trade-off calmly, instead of discovering the gap when a bill bounces.

A household budget usually starts with take-home income: wages after income tax and payroll deductions, plus any regular benefits or side income. Spending is then listed and grouped. Common groupings are:

• Fixed costs. Rent or mortgage, insurance and loan instalments that stay roughly the same each month; see fixed expenses.
• Variable costs. Groceries, fuel, utilities and entertainment, which change with behaviour and prices; see variable expenses.
• Saving and debt repayment. Money moved to a savings account, an emergency fund or extra payments on a credit card balance above the minimum payment.

The basic test is simple: planned spending plus planned saving should not exceed income. Where it does, the gap has to be closed by cutting spending, raising income or borrowing, and borrowing only moves the problem into future months as debt. Many people automate the plan by having pay arrive by direct deposit and setting standing transfers to savings on payday.

Several rules of thumb are widely taught. None is a law or a standard; they are frameworks people adapt to their own situation.

• The 50/30/20 rule. Popularised by Elizabeth Warren and Amelia Warren Tyagi in their 2005 book All Your Worth, it suggests roughly 50% of after-tax income for needs, 30% for wants and 20% for saving and extra debt repayment.
• Zero-based budgeting. Every unit of income is assigned a job (spending, saving or repayment) until nothing is left unallocated. The term also describes a corporate method, developed in the 1970s, in which each cost must be justified from zero rather than carried over from last year.
• Envelope budgeting. Cash, or a digital equivalent, is split into labelled envelopes for each category; when an envelope is empty, spending in that category stops for the month.
• Pay yourself first. Saving is taken out at the start of the month, and the rest of the plan works with what remains.

Research in behavioral economics helps explain why such simple rules work: people tend to treat money in separate mental "pots", and a rule that makes saving automatic removes the need for repeated willpower.

In a company, the budget is the financial version of the year's plan. Departments propose revenue and cost figures, management agrees a final version, and actual results are then compared with it each month in a variance report. A sales budget, an operating budget and a capital budget are often prepared separately. A cash budget, closely linked to cash forecasting, checks that the firm will have enough money on hand each week even if it is profitable on paper; a profitable plan can still fail if customers pay late. The result the plan aims for is usually stated as target net income.

Public budgets add a legal layer. In most countries the finance ministry prepares the plan, parliament or congress approves it, and spending without an appropriation is not allowed. A government spending more than it collects runs a deficit, financed by borrowing. Choices about the size and mix of public spending and taxation are part of fiscal policy.

A budget is only as good as its assumptions. Prices change, and a plan written when inflation is low can be out of date within months when it rises. Irregular costs (annual insurance, car repairs, school fees) are easy to forget; a common fix is to divide them by twelve and set the monthly amount aside in a separate account such as a money market account.

Budgets can also be too rigid. A plan that leaves no room for small pleasures is often abandoned, and the opportunity cost of time spent tracking every coin may outweigh the benefit for people with a comfortable margin. For businesses, fixed annual budgets can encourage managers to spend the full allocation before year-end so it is not cut next year, one reason some firms prefer rolling forecasts. Over time, a working budget should show up as rising net worth: more saved, less owed.

• MyMoney.gov (U.S. Financial Literacy and Education Commission)
• FDIC Money Smart