Economizing with a Budget

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Economizing with a Budget

The key to a successful financial plan is managing one’s cash flow. Did you ever meet someone who complained, "There is too much month left at the end of the money"? This can happen more often than one thinks. In fact, it is quite a normal occurrence, even for those in good financial shape.

Why it’s easy to fall into debt

Here is why. Most persons have a steady stream of income each month, but their expenses may vary so much that some months have more expenses than inflows from income. This is usually not a problem, because on those months when the income exceeds expenses, the excess income goes into savings (a negative inflow) that can be used later when expenses exceed monthly income. It only becomes a problem when monthly expenses exceed monthly income so often that there are not sufficient savings to provide for the difference. When that happens, one is forced to borrow money to balance the inflows and outflows. This leads to increased expenses, because the cost of borrowing money itself (interest) increases monthly expenses.

To stay out of debt, you must economize

To avoid this, one must economize. Economizing is merely determining how much one can spend on each expense item so that the expenses do not exceed income over time. Since "income" is the limiting component, one economizes by incurring expenses based upon the amount of income one expects to receive over time. If you had an expectation of $50,000 of income over the next 12 months, you couldn’t very well plan to spend $75,000. That just doesn’t make sense. On the other hand, if you had an expectation of $50,000 of income per year for the next three years, and you wanted to spend $75,000 this year and only $37,500 per year (including interest on the borrowed $25,000) for the following two years, that would make sense, because the inflows from income would balance the outflows. If, instead, you spent only $37,500 per year for two years, you could spend $75,000 in the third year without incurring any interest charges—in fact, you would probably have earned interest on the unspent income for the first two years.

Plan your expenses to match your inflows from income

Economizing means planning your expenses to match your inflows from income over time. The key to successful economizing is in setting goals and putting them in order. One can usually predict future income fairly accurately. It’s the expenses that pose a problem. Some expenses are just not discretionary. But judge carefully. True, one must have a place to live, but how much one spends depends upon one’s goals and priorities. One must buy clothing, but how much one spends depends upon one’s goals and priorities. You can make a successful cash-flow management plan by projecting your expenses based upon your short-term, intermediate-term, and long-term income expectations, as well as on your goals and priorities.