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Managing my money
Managing my money

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2.3 Managing your budget

You’ve seen that households can receive income from a number of different sources. You know that assessing your position is always an important first step in financial planning, and assessing income is often one of the most important factors in financial decision making. One tool that can be used to do this is the budget.

To draw up a budget you start by looking at your cash flows. This involves measuring inflows and outflows of money on a regular basis. In the remainder of this week, you concentrate on inflows. The spending side – outflows – of the budget statement is covered next week.

There are four issues to be considered in measuring the income side of a budget. You’ll soon start to do this in practice.

First, the statement should record inflows of income in the relevant time period, such as a month or a week. For most people this will represent their net income: payers of standard rate Income Tax whose income consists of pay will already have been taxed via PAYE, and National Insurance contributions (and, for people in occupational pension schemes, pension contributions) will have been paid. Self-employed people, by contrast, are not taxed via PAYE. They will need to set aside the sums due for tax payments on their gross earnings. These sums are normally made in two payments to HMRC in January and July each year. However, some people will receive at least some income paid gross, such as some investment returns or state benefits. In this case the gross income should be recorded, but it must be remembered that there may be tax still due on this income at the end of the tax year, and tax payments may be an expense that will need to be factored into the budgeting process.

Second, it is important to include all the different sources of income, such as income from paid employment, self-employment, savings and investments, pensions and social security benefits. Any additional income is recorded under the ‘other’ category.

Third, it is important to take account of how frequently different types of income are received. For instance, a household may receive a combination of weekly benefits and monthly pay. In order to standardise these different frequencies of income for a monthly budget, the technique is to calculate an equivalent annual income first (for example, by multiplying a weekly income by 52) and then estimate a monthly income equivalent by dividing this figure by 12.

Fourth, the income side of the budget can be drawn up at the level of the household or individual. The choice will depend on household composition, but to get an accurate figure of total household income it is necessary to include all income earners.

Figure 8