Budget Like A Master: Honing thy Budgeting Skills
A budget is an incredibly powerful tool to manage your income and expenses. By having a budget, you can identify expected income and expenses that allow you to make better decisions and more controlled spending behavior. This is pretty common knowledge. But in reality, a lot of people don’t budget. The result? Uncontrolled spending and lack of savings that may snowball to less financial security and great financial stress. This is why budgeting is really important, especially on a personal level, that’s why we want you to use budgeting as a personal tool for financial independence.
Budgeting is not only about numbers, it is also an art; it involves creativity in making a budget plan that works as well as on making assumptions that reflect reality. To master the art of budgeting be the best budget master, we’ll go through the actual process of making a personal budget by looking into budgeting assumptions, one’s goals in budgeting, the two components of a budget, and designing a budget. This read will be quite a long one but we assure you that those budgeting skills will be honed by the end so brace yourself as you become a budgeting master!
Budgeting Strategies
When making a budget, you can’t just proceed to plot your income and expenses without having some budgeting strategies. Without a strategy, you can’t have a structured budgeting plan that will allow you to allocate your money in the best way possible. Some of these strategies are the 50/30/20 Rule, the Envelope System, and the Pay-Yourself-First System. In choosing a budgeting strategy, you must consider your priorities and preferences.
For this article, we will use Ate Marie as an example. Ate Marie is a customer service team leader with the goal of paying for the PHP 150,000 down payment of a Toyota Wigo after 2 years. She wanted to create a budget to help her allocate her money and direct her to her goal. Based on Ate Marie’s preferences and priorities, we chose the following budgeting strategies for her:
- The Top-Down Approach. For many people, savings are defined by how much is left after paying for expenses. This usually leads to very small savings or none at all. In this approach, our savings lead our budget. You set aside the savings first and what’s left will be allocated for expenses. In this way, the savings take priority and the expenses will adjust for the savings.
- 50/30/20 Budget Rule. This is a budgeting system for beginners where you allocate 50% of your income to your needs, 30% to wants, and 20% to your savings or for paying debt. Note that the allocation rate can be revised and suited to your needs. For this case, we’ll go with the 50/30/20 allocation.
For this article, our main tool for budgeting is a spreadsheet since it is more customizable and comprehensive. However, there are other ways to make a budget such as apps like Mint and PocketGuard.
What’s your goal?
When making a budget, you can have a long-term goal and a short-term goal. Basically, these goals will answer the question: why do you want to budget your money? This will help you direct your budget and stay focused.
The long-term goal is what you want to achieve in the long run as a consequence of having a budget. This may be a house, financial independence, to pay back a debt, retirement plans, etc. By knowing what your long-term goal is, you can make a budget that is oriented to achieving this goal. The short-term goals are goals attainable in a short span, usually a year. These can be a new phone, appliance, vacation, etc. Note that the long-term goals of some people can be short-term goals for some. These are not absolute since every person can actually design their own goals. What’s important is to identify these since the combination of the long-term and short-term goals will decide how our budget will go.
When setting a goal, always make sure that it is SMART — specific, measurable, attainable, realistic, and time-bound. A specific goal is well-defined. You don’t just say that you want a car; you specify the model of the car and whether you want it brand new or not. Next, goals must be measurable so that it will be easier to factor in the budget and so that you can track your progress. In the case of the car, you must know its price so that you know how much to earn and save for the duration of the budget. Goals must be achievable; otherwise, it’s like wishing for a car without even having a job or any source of income. When we say that a goal is realistic, it means that you have the resources and time to accomplish it. If you are making a budget with the goal to pay for the PHP 150,000 down payment of a brand new Toyota Wigo within a year yet your salary is PHP 30,000 a month. This may be unrealistic and the tendency is that you will make a budget that’s too restrictive and chances are you might end up not following it.. Lastly, the goal should be time-bound. It needs to have a start and finish date. Without which, there will be no sense of urgency and you will feel less motivated to achieve the goal.
Let’s analyze Ate Marie’s goal. As stated earlier, her goal is to pay for the PHP 150,000 down payment of a Toyota Wigo after two years. This is specific because the actual car is stated. This is also measurable since there is a specific amount of downpayment required. This is also achievable and realistic since she has a source of income and, thus, the capacity to actually pay for that downpayment (this can further be proved when we analyze her income and expenses later). This is also time-bound given the 2-year period she stated for attaining the goal.
Now that we know our goal, we must look into the three important components of budgeting: income, savings, and expense.
Income
Your income is your source of money — this can be your pay from work, business earnings, allowance, gains from investing, etc. In this case, let’s talk more about salaries since it is the source of income for most people. When we talk about salaries, we start with the gross pay which is the amount that an employee actually earns. This however, is not the amount that an employee actually gets. What they actually receive is after-tax income which is equal to gross pay less deductions and tax. To understand more, let’s look closely into these in the following paragraphs.
Salary deductions are law-mandated deductions that an employer must subtract from the salary of an employee. These are SSS, PhilHealth, and Home Development Mutual Fund (HDMF)/Pag-IBIG contributions, withholding tax, loan payments, tardiness and absences, and other deductions from company-specific policies. For this article, we’ll be talking about salary deductions that apply to most employees, namely, mandatory government contributions and withholding tax.
Mandatory Government Contributions
There are three main mandatory government contributions that employees make: contributions to SSS, PhilHealth, and Pag-IBIG.
SSS, or the Social Security System, is a state-run insurance company. Employees make contributions to this government agency for their pension plans. To compute one’s SSS contribution, a contribution table can be used. You can see below the SSS contribution table for employed, self-employed voluntary members, and non-working spouses (for OFWs and household help workers, see this). For Ate Marie, the contribution table below applies to her. As such, with gross pay of PHP 35,000, Ate Marie’s monthly salary credit is 20,000 and she’s expected to contribute PHP 800, as seen on the EE column.
The next deductible is the contribution to PhilHealth, or the Philippine Health Insurance Corporation, for the health insurance of the employees. The contribution here is equally divided between the employee and employer. In Ate Marie’s case, her total contribution is PHP 1,050 for 2020 (PHP 35,000 * 3%). Since the payment for the contribution is equally divided between employee and employer, the dedication to Ate Marie’s Salary is PHP 525 (PHP 1,050 / 2). In cases where the gross pay is below the salary floor of PHP 10,000 or above the set ceiling, the total contributions are computed using the minimum threshold or set ceiling.
Lastly is the Pag-IBIG contribution of the employees. Pag-IBIG or the Home Development Mutual Fund (HDMF) contributions go to a regular savings program that earns dividends. Note that the maximum monthly compensation used in computing employee and employer contributions is PHP 5,000. For Ate Marie’s case, since her salary exceeds PHP 5,000, her contribution will be PHP 100 (PHP 5,000 * 2%).
Withholding Tax
Withholding tax is based on taxable income. The formula to taxable income is as follows:
For Ate Marie, her taxable income is approximately PHP 33,575 (PHP 35,000 — PHP 800 — PHP 525 — PHP 100). After calculating this, we can use the table below to determine her withholding tax. Since her monthly taxable income is between PHP 33,333 and 66,666, her withholding tax is equal to PHP 2,560.50 (PHP 2,500 + [25% * (PHP 33,575 — PHP 33,333)]). Note that the matrix below is only applicable until 2022. To make this easier, you can use BIR’s withholding tax calculator here.
After considering these salary deductions, we discovered that Ate Marie’s after-tax income, the actual pay she receives, is PHP 31,014.50 (PHP 33,575 — PHP 2,560.40). However, this is not only the basis of her yearly income. We still have her 13th month pay.
13th Month Pay
The 13th month pay is a mandated benefit that employers must pay to employees before the 24th of December of each year and is equivalent to 1/12 of the annual basic pay of an employee. This is a tax-exempt income. For Ate Marie, her 13th month pay is equal to PHP 24,000. According to her, she usually saves this 13th month pay to achieve her financial goals faster. As such, her expected income in a year is PHP 372,174 (PHP 31,014.50 * 12) plus PHP 35,000 which is equal to PHP 407,174.00.
Now that we established the important information when it comes to income, let us now plot this in a spreadsheet. Assuming a two-year horizon, this is how it will look like.
Now, why did the after-tax income change? This can be attributed to the change in the computation for the Philhealth contribution. This is why it is always important to always be updated on any changes in how contributions and taxes are computed. Also, notice that the 13th month pay is not included in the computation of the taxable income. This is because this bonus is non-taxable,
We already established the essentials of income. Since we are following the top-down approach in budgeting, we must first allocate to savings.
Savings
Usually, savings is a residue of income after deducting expenses. But since we are using the top-down approach in budgeting, savings will be our priority before expenses. As such, we will first deduct savings from income to know the amount that we can use for our expenses. Given the 50/30/20 rule, the percentage of income that will go to savings is 20%. Thus, for Ate Marie’s case, her savings for the first year will be PHP 6,202.90 (PHP 31,014.50 * 20%). What’s left of this will go to income. So, for the first year, Ate Marie has PHP 24,811.60 (PHP 31,014.50 — PHP 6,202.90) left to spend for a month’s expenses.
One important concept when we talk about savings is the emergency fund. An emergency fund is a contingency fund that we use to cover large, unexpected expenses like hospitalization fees and if you lose your job (which we hope won’t happen). We don’t touch this stash of money, even for our goals. Usually, this is equal to three to six months of living expenses. A three-month emergency fund is recommended for people receiving a salary and has stable employment. In this case, we will assume that 50% of the monthly savings will go to the emergency fund until it is already established equal to an amount worth three months of living expenses.
Now that we already established the assumptions for savings, we now plot it in our spreadsheet.
As you can see, we separated the money that we allocate to the savings account and the emergency fund. Also, unlike the table for income where we showed the income for the period, what we are presenting here is the cumulative balance or the total amount of money in the savings account or emergency fund from the starting date of the budget. Note that in the second year, we did not increase the amount of the emergency fund beyond PHP 74,277.30. This is because the emergency fund is only equal to three months of living expenses which is PHP 74,277.30 (PHP 24,759.10 x 3 months). In relation to this, if Ate Marie’s living expenses increase, this emergency fund must also be adjusted since the emergency fund is a function of the monthly living expenses. Another reminder, is that your return from investment, which we’ll teach you how to compute soon, is still not included in your savings. Exciting, right? Well, tone down your excitement for now because we will now proceed to the next important part of a budget because after deducting savings from income, we now do the job of allocating what’s left to expenses.
Expenses
Expenses include everything that you spend your money on which consists of usual items like food and utilities as well as payments of debt and insurance. There are lots of expenses that we need to consider. When assessing expenses, we must be honest. Otherwise, we’ll end up valuing our expenses too low that we’ll end up spending too much or valuing our expenses too high that we lose the opportunity to save more. We must not also give a huge allowance for our expenses or we’ll end up making unnecessary expenditures and lose that opportunity to save more and achieve our goals faster.
For our purpose, we can categorize our expenses into two: needs and wants.
Needs
Financial needs are spendings made on things essential for life and work. Usually, these expenses are recurring. Examples of financial needs are food, housing, transportation, and utility expenses. When making adjustments in a budget, very seldom do we decrease the amount allocated for financial needs or, even if we do, the decrease is not too much. Because a thing is a need doesn’t mean that you are the one paying for it. For example, students seldom pay for house rent using their own money while adults usually pay for it. In budgeting, we only factor in expenses that we actually pay for.
Now, how do we estimate these? Since these are recurring expenses, you can consult past spending information on these items from receipts, bills, bank statements, etc. If you really have no idea, you can make a rough estimate by searching for the average expense of a person within your area for an item of need. In addition, some people also pay for the needs of other people. For example, a mother or father must also pay for the needs of their children. These are but some of the things that we need to consider when estimating expenses.
Going back to Ate Marie, let us establish that she’s single and that she’s only paying for her own expense. Based on our budgeting strategy, she can allocate 50% of her income to her needs. For the first year, this will amount to PHP 15,507.25 (PHP 31,014.5 * 50%). Based on her grocery bills and receipts for lunch during workdays, the average cost of her meals per month is PHP 7,200. She also pays for rent equal to PHP 3,000. Her average electricity bill these past 12 months is PHP 1,500 and her average water bill is PHP 500. She also pays for transportation expenses which she estimated around PHP 1,000 based on the usual fare she pays for jeepneys and her usual bill when using Grab. She also pays for laundry which averages around PHP 1,000 per month as she gets her laundry done once a week and usually pays PHP 250 for it. Considering all these expenses, her current estimated monthly expenses totals to PHP 14,200. After subtracting this from our previous computation, there is still PHP 1,307.25 left. We can label this as additional expenses for needs for other needs not stipulated in the budget such as those for load and allowance for when the actual expense exceeds the budgeted expense.
Wants
Wants are expenditures you make to make life more comfortable and fun but you can live without. These are usually associated with your hobbies and lifestyle. These include expenses for gym memberships, Starbucks coffee, travel, and entertainment. Similar to financial needs, these can also be estimated from past billings and, if such information is not available, Google can be consulted.
Ate Marie’s budget for her wants for the first year is PHP 9,304.35 (PHP 31,04.50 * 30%). She likes going to a nearby gym which has a monthly membership fee of PHP 1,500. She also treats herself to a vacation every summer. Her past two vacations cost PHP 3,000 and PHP 4,000. From there, we can get the average of these numbers to estimate how much her next vacations will probably cost. Also, she buys a set of clothes every two months. Her usual expense is at PHP 2,500. She also spends an average of PHP 2,000 on gifts every December in preparation for Christmas. You can notice from Ate Marie’s expense that wants can be recurring and seasonal. This is why our budget is a monthly budget to better reflect these seasonal expenses. We allocate the remaining budget as an allowance for additional wants since our desires can be unpredictable (like seeing a good shirt in a store and wanting to buy that shirt even if it’s not included in the budget). By giving some allowance, we lessen the probability that we stray away from the budget.
Finally, we already established Ate Marie’s expenses. However, are we already finished? No. Note that the cost of goods and services is not constant. In reality, expenses usually increase due to inflation.
Inflation
Inflation is the general rise in the price level of goods and services over time. This can also be described as the decrease in the purchasing power of money over time. For example, your PHP 100 now can buy 100 candies but 10 years from now, that PHP 100 can only buy 50 candies (read this to know more about inflation).
For our purpose, the assumed inflation rate per year is 2.5%. This means that if the cost of a meal is PHP 100 now, the same meal may cost PHP 102.50 next year. Because of inflation, the expenses of Ate Marie will increase by 2.5% in the second year. You will also see that the allowance for extra expenses for both needs and wants decreased. Refer to the table below to see the specific changes in costs for the second year.
Now that we have already established the goal, income, and expenses, we were able to make an initial budget. What’s next is to check this initial budget with our goal.
Can we achieve the goal?
You can see below the initial budget that we made:
The goal of Ate Marie is to pay for the PHP 150,000 down payment of a Toyota Wigo after two years. How do we know if she already achieved this goal? In our case, we must look to the running balance of Ate Marie’s savings account. Did you already see it? Now, can she achieve this by using the budget and sticking to it? Yes! You can see that after two years, she will have enough money to pay for this downpayment — PHP 156,691 to be exact.
What if the goal is not achievable given your initial budget? Well, you have choices. You can either adjust your income, expenses, or goal.
Obviously, you have better odds of achieving your financial goal if your income increases. This can be done by having a higher paying job or starting a business alongside your current job. However, this is very hard to do in the short term.
Our second alternative is to adjust the expense. When adjusting expenses, you must first adjust your wants before the needs. When making adjustments, you must only adjust up to a reasonable level. By being reasonable, you can still live within your budget. If you adjust your budget to an unreasonable level in such a way that the budget for needs or wants is very small, the tendency is that you’ll end up not following your budget. This alternative entails a change in your strategy. For example, in Ate Marie’s case, we decided to remove the allowance for other expenses. This means that the portion of income allocated to expenses will not be equal for each month and the 50/30/20 rule will not also hold. Well, this is fine as long as the budget is reasonable.
Our last alternative is to adjust your goal. Maybe you can find a cheaper alternative that is achievable within your time frame or you can adjust the time frame itself.
Mobilize the budget
Now, we already made a budget. Hooray! What’s left is to mobilize the budget. How can we do this?
First, always remember to stick to the plan. A budget is only numbers unless you really live up to it with the discipline needed to stick to it. Try not give in to temptation. Upon receiving income, immediately separate your savings. What you can do to help you manage your money better is to make separate bank accounts for expenses, savings, and emergency fund.
Second, track your expenses. Always keep receipts, or list down your expenses. By doing this, you can track your actual spending and compare it with your budget. Are you within the budget? We hope you are.
Third, constantly check your budget and make revisions, if necessary. Sometimes, change happens. For example, inflation is higher than you expected. This means you need to adjust your expenses. Maybe you have a higher income due to a promotion. This means a revision in income. There are a lot of changes that may occur. This is why you must periodically check your budget to see whether it still holds given the current situation.
Information overload already? We hope not because there’s more to budgeting than just knowing it. Now that you know how to make a simple budget, maybe you should apply it. Have a financial goal? Try making your own personal budget to test what you learned here and to help you achieve that goal. Also, we saw that one of the components of a personal budget is savings. In our example of Ate Marie, her savings are just savings — mere cash stashed in some bank’s vault. What if we can do something with that cash? We can invest that cash, let it grow, and realize returns that will enable us to achieve our goals faster.
To apply your learnings in investments, watch out for the next article of UPJFA’s Pisopedia on investment returns. That’s it for now. See you again!
