Many people refuse to create budgets because they believe it restricts their freedom. Today, we will delve into why you, as a clever African, need a budget. According to the Merriam-Webster dictionary, a budget is “an estimate of income and expenditure for a set period of time.”
When I first joined the workforce, I was making and spending a decent amount of money. At the time, I had no idea exactly how much I was spending or saving each month. I never kept track of my expenses or savings because I assumed my paycheck would replenish my bank account every two weeks. But then, one afternoon, I listened to a speech by Martin Luther King Jr. entitled “What is your life blueprint?”. That speech changed my mindset. I was motivated to develop a blueprint for every aspect of my life, especially in regards to my finances (see post: The need for a financial blueprint). Yes, you guessed it, I created a budget – a robust budget that enabled me to answer some critical questions I had never thought of before. Creating a budget helped me to answer the four questions below and in turn improved my financial situation, I hope it does the same for you.
1. How much am I spending each month?
Cash flow is the consistent cycle of money going into and out of your accounts. If you do not keep a keen eye on your cash flow, it becomes very easy to mismanage your funds. By creating a budget, you will be able to analyze your spending habits, capture trends in your expenditure, and monitor your account balances over time. In addition, understanding your cash flow will help you pinpoint ways to cut back on expenses in order to save or invest.
2. What am I spending on?
It’s good to know how much you are spending each month, however if you do not know exactly what you are spending your money on, that is not beneficial for you at all. With a budget, you can keep track of the items you tend to spend your money on. Understanding your expenses will enable you to set limits on how much you want to spend in each area of your life; whether it be food, housing, clothing, or entertainment.
3. What is my net worth?
In short, net worth gives an accurate picture of an individual’s wealth. Basically, it is the difference between your assets (cash, investments, etc.) and liabilities (expenses, loans, etc.).
Net worth = Asset – Liabilities
Let’s assume you graduated from college making 50k a year before taxes (which is roughly 34k after taxes). You’ve never had this amount of money in your life so you begin spending like never before (spending 5k in the first year). You have a student loan balance of 40k of which you pay 1k each month. You are also paying 1k in other monthly expenses (rent, credit card, etc) that’s a total of 24k a year in payments — let’s calculate your net worth:
Asset = Saved after 1 year ($5,000)
Liability = Loan balance after 1 year ($28,000) +
Loan Payments made after 1 year ($12,000) +
Monthly Expenses after 1 year ($12,000) + = $52,000
Net Worth = Assets ($5,000) – Liability ($52,000) = – $47,000
As you can see in the above illustration, your financial state is not reflective of the salary earned after the first year of work. Many people dig themselves into a deep hole of financial debt by increasing their liability and decreasing their asset contributions; something they regret later in life. There are so many young people who are oblivious to this fact, because they do not have a budget, which consequently results in them having a negative net worth.
4. Are my financial goals on track?
Developing a budget helps you to track the progress of your financial goals. As we stated before, every clever African needs to set financial goals that are realistic and are in alignment with their budget. Goals help drive your budget in order to help you save or spend effectively each month.
While creating a budget can be time consuming and tedious, there are several tools available that will enable you to automate this process and gain rich insights. In our next post, we will discuss different resources that are available to help you create a budget efficiently and effectively. However, these four questions above should inspire you to create and use a budget today!
THE CLEVER AFRICAN: INVEST IN YOU
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