MSE’s Academy of Money
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MSE’s Academy of Money

9 Building your budget

It’s time to start building your budget. Before you do so, watch this short video which sets out the simple steps involved.

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Transcript: Video 2 Building your budget

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NARRATOR:
How to build and manage a budget. Building and running a budget is the key foundation for good personal financial management, and it’s easy to do. An annual budget provides a comprehensive overview of your income and your outgoings.
Start with all your income, including earnings from work, benefits, pensions and investments. If you’re not sure about any income, it’s best not to include it, then if it comes, it’s a nice surprise. Then set out your forecast spending, but divide the items between essential and non-essential or discretionary spending.
Set out essential spending first. These are items you have to pay for each year, so this will include mortgage repayments and rent, council tax, utility bills, income tax and national insurance if you’re self-employed, essential insurance costs, for example, home and car insurances food and drink, broadband, and mobile phone bills. When that’s done, add up the essential spending items.
Now, focus on the discretionary areas of your spending. These are still items you’d expect to spend money on each year, however, it’s up to you how much you spend on these. The items here include clothing, holidays, club memberships, meals out, birthday, and Christmas presents.
In here, it’s also best to add a section for money you’re putting aside for a rainy day fund, unless you already have one. This will help pay for car repairs or a new washing machine if you have problems during the year. Now, add up the forecast discretionary spending and your essential spending.
Compare your total income with your total spending. Have you got excess income or excess spending? If your spending exceeds your income, then you’ll have to see where you can cut back to avoid having to borrow money, or you’ll need to draw on savings to cover the gap in income. It’s easiest to focus on cutting back the non essentials, but always check you’re paying as little as possible for the essentials. For example, could you switch to a new energy supplier to pay less for your gas and electric bill each month?
If you have more income then you’ll spend, you can use it to add money to your savings, whether that’s for a specific purpose, like a new car, or buying a home, or just to have something set aside for a rainy day. If you’re now into your budgeting, you can take your annual budget and use it to work out your income and spending for the coming month. This gives a picture on a more practical level of the amount you might have in your bank account and what it needs to be spent on, whether that’s paying the month’s essential bills, or putting something aside this month for a holiday in six months time. It’s important to have both the annual budget and the monthly one, as you’ll find that spending varies quite a bit from month to month. Some items you’re spending, for example, paying for car insurance or holidays, only occur in some months rather than every month.

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End transcript: Video 2 Building your budget
Video 2 Building your budget
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While you need to make a budget that works for you, there are some key rules you should think about before starting.

  • Make sure the time horizon is long enough to capture all your income and spending. Working to just a weekly or monthly budget may miss spending on holidays, gifts or annual insurances.
  • Start your budget with your income before moving on to your expenditure. Only include income that is certain or at least likely. This way, anything on top is a pleasant surprise.
  • Break down your spending as far as possible. This will help you see exactly where your cash is going if you find you need to rein in your spending.
  • If you’re not sure how much something will cost (e.g. your phone bill) it’s best to overestimate and have cash to spare, rather than underestimate and not have enough.
  • Divide your spending between ‘essential’, ‘desirable’ and non-essential’ – as per the activity you completed in the previous section. This really helps if you need to cut back on what you spend as you can start by trimming non-essentials.
  • Add in an amount for unexpected spending, e.g. to cover replacing household goods that break down. Having this emergency fund for unexpected expenses means you don’t have to resort to panic measures (like borrowing on a credit card).

It makes sense to have an annual budget, but also to break it down month by month.

The annual budget will present you with that high-level picture of your finances and whether over the course of the year you are spending beyond your means (bad news!), or living within your means and potentially able to save up (good news!).

The monthly budget will help you manage your day-to-day money, indicating if this is a month of heavy spending (e.g. December, with its Christmas spending for most people) or a month of light spending (e.g. February, which is a short month when people do not tend to go away on holiday, when Council Tax is not normally payable and when the Christmas bills have been paid). These monthly snapshots will also highlight when you might have to draw on savings to cover a month of heavy spending or place money in savings when the monthly spending is relatively low.

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