October 05, 2021 | By: Anna Guglielmi

What Is Budgeting & What Is Its Purpose?

Budgeting

Odds are that if you spend any time at all researching personal finance topics, you’ll come across more than a few blogs about budgeting—maybe even this blog in particular. What is the definition of budgeting and why is it important, you ask?

In this blog, we’ll talk about the definition of budgeting (including a couple of different budgeting frameworks), why it’s important, and some tips to help you stick to your budget once you’ve made one.  

What Is Budgeting?

A budget can be explained as an estimate of future income and expenses. The practice of budgeting is a basic part of managing your personal finances. It’s often a critical part of a financial plan to get (or stay) out of debt. Having a budget means keeping track of income and spending to help maintain awareness of when expenses are getting out of hand (and finding ways to cut back on some non-critical costs).

One common tool everyone should use for their budgeting needs is a monthly budget planner template. This helps people of all financial skill levels set, and then stick to, a reasonable and achievable budget.

Budgets can come in different styles. For example, some people follow a zero-based budgeting strategy, while others might use a capital budgeting strategy. Not every kind of budget planning strategy needs to account for every little thing (though some do).

What Is Zero-Based Budgeting?

This is a budgeting strategy that got its start as a business money management tool. Here, every item in the budget is justified from a “zero base.” This means that every last dollar is being put to work in some capacity—there isn’t any idle money that doesn’t have a purpose.

Zero-based budgeting is often ideal for people who are working to clear a minor debt or want to start saving up for retirement (or some other financial goal). Within this kind of budget, any income left over can be applied to the budgeter’s primary financial goal.

One of the major drawbacks for some is that it can be a little stressful to keep such a close eye on their spending and income to ensure that their budget is zeroed out at the end of each month. However, even on a zero-based budget, it doesn’t have to be difficult to zero out if you find yourself with a surplus—simply take the excess and put it toward one of your financial goals!

What Is Capital Budgeting?

Capital budgeting is a practice that has been around for a while (considering that the University of Alberta has a paper on the topic dating back to 1993). Like zero-based budgeting, capital budgeting started as a tool for businesses. It’s a process where the business evaluates a potential project or investment to determine if they should be approved or not.

For private budgeters, capital budgeting can play a big role in determining if a particular financial goal is feasible. By taking a look at their income, expenses, and the cost of meeting their goals, budgeters can find out if they have a reasonable shot of achieving what they want to do or if they need to go back to the proverbial drawing board.

Why Is Budgeting Important?

Now that we’ve explored the definition of budgeting, what is the purpose of budgeting and why is it important? Why should you spend time and energy analyzing your income and expenses—and then plan around those things to find ways to save money (or at least control your spending)?

One reason is that it can help you get or stay out of debt. Without some means of comparing your income against your spending, it’s all too easy to fall into a pattern of severe overspending. This is a problem that can sneak up on virtually anyone—especially when you consider the risk of catastrophic events that really hurt your income or your household in some way.

For example, say that Bob has a monthly income of about $3,500. This is a pretty respectable income—not the highest, but more than some people make. Bob lives largely paycheque to paycheque, spending most of his money and going broke just in time for the next paycheque to clear.

He isn’t accumulating much debt, but he is riding the line close to overdrafting his account pretty closely. Then, one day, Bob loses his job because his place of work is forced to close. While Bob is able to apply for (and get) support through employment insurance (EI) benefits, it isn’t nearly enough to support his normal spending habits.

Even with EI, Bob finds himself racking up debt while he hunts for a new job—applying purchases to his credit cards to cover for a lack of funds, then paying the minimums when he gets his benefit payment. By the time Bob has a new job, his debt has skyrocketed to the point where he can barely make ends meet even after he’s “tightened the belt.”

This sounds like an extreme example, but it’s all too common a scenario. This is especially true after the COVID pandemic. In 2019, the unemployment rate in Canada was 5.73% but it jumped to 9.6% in 2020 (Source: Statista)—an increase that can be largely attributed to economic difficulties caused by the pandemic.

Preparing for such emergencies is simply one reason to start budgeting early, before you think you need it. Other reasons include (but aren’t limited to):

  • Ensuring you can retire comfortably (or early);
  • Avoiding getting into bad spending habits;
  • Saving up for an education (yours or your future child’s);
  • Building up your credit score to get favorable terms on financial services; and
  • Saving up to buy your dream home/wedding/car/other major expense.

In short, making and sticking to a budget is a vital part of achieving your financial goals.

Tips for Creating a Budget

Okay, you’re motivated to start budgeting hard so you can save up for your future, meet some big and impressive goal, or just look at your creditors in a few months and say: “No more debt!” The question now is: “how can you get started on your budget?”

Here are some basic budgeting tips for first-timers to consider:

Consider the ABC’s of Budgeting

When coming up with a budget, it’s important to stick to a simple plan. Trying to track every penny you spend and log it all in a big spreadsheet can easily turn into such a big hassle that it becomes demotivating. So, it might be better to start simple and focus on the ABC’s of budgeting.

What are these ABC’s? Credit Canada CEO Bruce Sellery defines them as:

  • Analyze. Take a look at your income and expenses.
  • Brainstorm. Come up with ideas for what you could change for the future (though you don’t have to make answers for every budgeting challenge you have).
  • Change. Make commitments to major changes that you need to follow through on to meet your personal finance goals.

Keeping it simple makes it easier to focus on sticking with your budget—you can always step things up later as you get more comfortable with managing your finances.

Focus on Sustainable Spending

Consider the resources you have to work with and focus on making large, but sustainable changes over trying to track every little thing. There are often far too many expenses in your day-to-day life to make tracing everything at once easy. Also, it can lead into a mindset of scarcity, where your budgeting efforts become all about what you can’t do instead of what you can do—we’re CANadians, not CAN’Tadians.

For example, in your analysis and brainstorming session, you determine that you’re spending too much on your house, have a bit too much debt, and are making a lot of unnecessary shopping trips. You could consider moving from your current home to one that is in a somewhat less pricey neighborhood to save money, cut shopping trips to the mall, renting out space in your home (if possible), getting another job or finding a way to get paid more at your current workplace, or focusing on debt repayment.

In a similar situation to the one outlined above, a family chose to move to a less expensive home and cut the trips to the mall. Bruce shared their story in a video interview featured on Cityline—noting that after the move, the family was able to demolish their consumer debt very quickly and start saving for their kids’ education fund.

Use a Budgeting App

There are a ton of tools out there that can help you make (and keep up with) your budget regardless of the budgeting strategy you use. One of the most powerful and versatile types of tools is the budgeting app.

Finding the best budgeting apps can be a challenge simply because of how many of them there are. Some factors to consider when looking at budgeting apps include:

  • Whether they integrate with your banking app (or apps, as the case may be)
  • Security features to protect your data
  • The cost of installing and using the app
  • What credit monitoring capabilities the app has
  • How easy the app is to use (vs how versatile it is)

Many of these apps are free (or very inexpensive). You could also use your bank’s free banking app—odds are that it will have some budget-making features you could benefit from!

Need Help Managing Your Debt?

If you need credit counselling in Ontario (or anywhere else in Canada), Credit Canada is here to help! Our experienced team of Credit Counsellors have helped thousands of people get out (and stay out) of debt over the years. And, we want to help you, too!

Why? Because, nobody should have to struggle with debt alone. Reach out to our team today to get started, or call us at 1.800.267.2272.

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