The Budgeting Process

Napoleon was said to be a genius and was credited for many of today`s common institutions, and many revolutionary concepts in his day. One of the things that made him supreme in my mind was his reputation as an organizer. According to historical accounts he never slept the night before a battle. He was up all night writing out orders by candlelight for every possible contingency in a battle that had yet to unfold. He knew that in the fog of battle, time was important and little details could make the difference between victory and defeat. In today’s world, one of the biggest battles people face is how to make ends meet financially.

Rarely are household financial courses offered in high school. If our parents didn’t have a good grasp of finances, then all too often we were destined to repeat their mistakes. Many people have become resigned to a life of quiet desperation. Part of the issue is financial literacy. There is a language of finance, and it takes a bit to learn what is meant by certain terms. Concepts however are even more important in mastering personal finances. There are a few basic concept which if understood and applied can make the difference between financial victory and defeat in your own households.

Assets vs Goods

The first concept, though not necessarily the most important, would be to understand the difference between an asset and a “good”. In this day of rampant consumerism, it is not uncommon for people to regale us about the triumphs of a day’s shopping and emphasizing the “great deal” they got. Highlighting their virtues and shopping acumen in the process. One thing to keep in mind, however, is that goods depreciate (diminish in value over time), while assets will hold their value or even increase in value.

Matching Assets with Debt

I remember a business case in University in which the professor explained how a business went bankrupt, (the same could apply to a person), when they financed a short term asset with a long term Debt. Why does that matter, I recall asking. The professor illustrated the answer by using an absurd example. He explained that by miss-matching debts and assets, it would be the same as the person who bought a Big Mac using a credit card and financed it over several months… all traces of the Big Mac would be long gone, yet the interest payments would be still felt for days and even months to come. So he said it’s ok to use debt to buy assets, but make sure the asset with a short lifespan are paid for with short term debts, and conversely assets with a long life span are financed with long term debt; don`t use a credit card (short term debt) to finance a house (long term asset).

Budgeting

In 14 years as a financial planner, I would say this is the most important tool people can use to ensure their financial success. I have learned 3 different approaches to budgeting. 1) the detailed budget, 2) the vague budget, and 3) the No-budget-what-so-ever method. When I meet with clients for the first time, I am surprised when I meet one that has a budget and brings it to our first meeting. Clients often say that they run one in their head.

I recount to clients a concept I first learned from a radio show on CBC in which the guest said, `financial independence is extremely simple: just live on less that you make`. I frequently chant the following phase to myself when making a purchasing decision that involves increasing my debt level. The saying goes: “When your outgo exceeds your income, your upkeep will be your downfall“. According to Google its origin is attributed to Bill Earle.

Many people don’t budget because it takes time, its tedious, its gets outdated in a short period due to changes in our lives, and sometimes it causes `marital dis-harmony`. I`ve been told that money is the biggest cause of divorce in North America. Be that as it may, it’s still the single most important step to financial security. Instead of budgeting every month, I will create an annual cash-flow projection once a year or if things are looking tight. It helps me understand where our family spends money, how much money we, (net of taxes), bring in and when. It’s like a series of budgets all linked together. It has a beginning balance, income and expenses for each month, and an ending balance that becomes the beginning balance for the next month. I`ve attached a copy and you should be able to modify it to reflect the particulars of your life. The reason I use this for budgeting is due to its flexibility… in my world I have house insurance due in July and extra bonus income sporadically throughout the year, so it’s nice to know if buying Christmas presents in December will hurt when house insurance is due in July.