Australian’s have the highest household debt to GDP than any other country in the world according to LF Economics. Since 1960 this has been steadily rising and we overtook Denmark in 2015.
Australia has approximately $2 trillion in unconsolidated household debt. This is high when compared to GDP of $1.6 trillion.
Borrowing money can be beneficial for building wealth. However, there are risks involved. If you’re unable to keep up with your debt payments, your debt may increase. If this persists for any period of time you can reach a point where it’s not possible to recover.
So, we Australian’s seem willing to use credit to pay for purchases. That’s fine if managed properly and one of the fundamental tools to managing finance is budgeting.
What is a Budget?
A budget is a plan that, if you follow with some discipline, will help you make sure that you don’t spend more than you earn. It’s a financial tool for analysing and managing your money. It will provide you with two key benefits:
- A budget will identify if you spend more than you earn. As you know, spending more than you earn consistently will lead to debt problems. So it’s important to know how much you’re earning and how much you’re spending in the same period of time.
- It will enable you to prioritise your spending to ensure that you can come out financially and provide a tool for tracking your progress over time.
The budgeting process – how to create a budget.
The process of creating a budget is called budgeting. It’s actually quite easy but will need a little time to get all the required information in order. Let’s consider the main steps:
1 – Set aside some time to prepare your budget.
You’ll need at least an hour to get through the process. The first step is to gather all your documents. For example:
- Bank statements – at least 3 months worth of transactions. More is better.
- Credit card statements.
- Income statements from your employers or your bank account if self employed.
- Copies of household bills like water, electricity, rates, etc.
- Other income from shares, pensions, annuities etc.
Having all this information will make the next steps easy.
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2 – Record all your income
You’ll need to add up all the income you earn. Make a list of all sources of income and the amounts earned from each. Some may be annual, some monthly and some weekly so you need to determine a time frame for measuring and make sure you’re apportioning your income accurately.
I prefer to budget monthly. In that case, calculate how much income you receive after tax every month. If you have sources of income that you receive annually, you can either add that amount to the relevant month or apportion it across all months.
3 – Add up all your expenditure
Now you need to work out how much you spend each month. This information will come from your bank statements, credit card statements and bills.
At this point it’s useful to categorise your spending. That is, allocate each expense to a category like Food and Groceries, Eating Out, Car Expenses, Insurance, Entertainment etc.
Again, you’ll need to apportion the spend to the month it’s incurred or spread the cost over many months.
Consider adding a “savings” category. It’s important to get ahead so you need to make provision in your budget. It’s also a good idea to accumulate some savings in case the unexpected happens.
4 – Review your financial position
Now you’re ready to see if your income exceeds your expenses by totaling each column. Now take your total monthly expenditure away from your total monthly income and hopefully you have a positive total.
If your balance is negative then you have a budget shortfall and this needs to be addressed. We’ll cover that in the next section.
5 – Prepare your budget plan
It’s time to prioritise! You might need to reconsider your discretionary spending if you’re not coming in on your budget. Discretionary spending is those expenses you can do something about like restaurants or entertainment. Other types of spending can’t be changed like rent for example. There’s not much you can do with these non-discretionary spends (apart from move to a lower cost home of course).
A word of advice: Be realistic. You don’t want a plan that limits your lifestyle so much that you just don’t enjoy life. Small changes can make a big difference. For example stop buying lunch at work and make your own. Even though this might be a small amount, it all adds up.
Budgeting is an important financial tool. It will help you to control your financial position and let you know when you’re spending too much. It will inform you so that you don’t make that big spend that you didn’t know you couldn’t afford (before you had a budget).
We wish you all the best in getting your finances on track with budgeting.
Learn how to create a budget and get on top of your finances.