#Budgeting, #Household Math - Budgeting... What's it good for?

Question

It's great that I read everywhere about the need for a budget, but what is it?

Answer

A budget is a tool that people use to figure out their financial health.

Analysis

I like this definition enough that I'll repeat it:

A budget is a tool that people use to figure out their financial health.

The most basic question that can be answered is "Am I living within my means?". More complicated questions can also be answered, such as "Can I afford that expensive thing?". Questions involving more involved financial questions, such as "At what age can I retire?", will probably require a Personal Wealth Plan of some sort - simply analyzing monthly spending probably will be insufficient to answer that kind of question.

The main idea behind the budget is to see where your financial strengths and weaknesses are. Where there are financial weaknesses, you can then develop strategies to deal with them. For instance, if it turns out expenses are higher than income, the budget can identify that that is the case and then steps can be taken to address it.

To budget, we look at the two sides of financial life - Money coming In and Money going Out. In future posts, I'll reference topics in the post about the Statement of Cash Flows for a business because there will be some overlap in concepts.

The first place to start is to think about your expenses and how often they occur. For most people, the big expenses occur once per month (rent/mortgage payment usually being the biggest of them all). And so, in general, it's best to work with a budget that looks at a monthly timeframe (we'll deal with non-monthly expenses and incomes in their respective sections).

I think the last thing to say about what a budget is is that it's something that can be quite individualized. Depending on how exacting you'd like to be can greatly affect the budget. What are the items you want to track? What are the items you don't want to track? Generally if there is a lot of guilt and shame involved, like perhaps the "amount of money spent at coffee shops" or "the amount of money spent online shopping", those are items that need the most attention!

In future posts, we'll talk about the How of budgeting...

This post is part of a series on budgeting - Budgeting 101

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As always, comments and questions are welcome!

#Accounting - The Statement of Cash Flows

Question

If "cash is King" like you said in your earlier post, then is there an accounting statement that shows cash use by a company?

Answer

Yes there is - the Statement of Cash Flows

Analsys

I did previously state that there is an adage in business that "cash is King". And you are absolutely right that there needs to be a report that shows the cash condition of a business. To that end, a report was created that is called the Statement of Cash Flows and it specifically tracks the cash activity of a business. Since it is a report that shows change over a period of time, it is akin to an Income Statement in that it shows a range of time rather than a snapshot of a status (like the Balance Sheet).

The way the report works is that it starts with a company's Net Income number, which is generated under the accrual method of accounting. It then dissects that number, looking at all the changes to cash (and, in fact, the entire balance sheet) due to Operations, Investment activity, and Financial activity.

In the Operation section of the report, all the changes that happen on the balance sheet (say for instance that Receivables increase by $10,000, that number is backed out. If Payables increase by $10,000, that activity is also backed out) that relate to Short Term assets and liabilities (short term meaning those assets and liabilities that are anticipated to be held for one year or less).

In the Investment section of the report, all the changes that happened related to the Long term assets are shown. This will relate to the purchase and sale of fixed assets and other long term assets.

The Finance section of the report shows all the changes related to Long term liabilities and equity, such as changes in bank loans (acquisition of new funding and the paying off of balances), and also changes related to the issuance/cancellation of shares.

All these changes are applied to the cash balance at the end of the prior term and results in the new cash balance (at then end of the current term).

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Comments and questions always welcome!