Budget: Definition and Types
Updated July 21, 2022
Whether you're working on your personal finances or trying to cut back on business expenses, creating a budget is a useful way to evaluate your income and spending habits. Creating a budget can help you better plan for your financial future.
In this article, we will define what a budget is, the various types and the reasons why you should have one.
What is a budget?
A budget is a financial or spending plan based on your income or revenue. It estimates the amount of money you'll spend based on how much you make in a given period. While some expenses need to be paid monthly, others will be one-time fees. A budget helps you plan for these expenses as they arise.
If you're hoping to become debt-free, reduce your spending or save money in general, a budget is a great way to measure how much money you make to how much you're spending. For example, a budget will let you know whether or not you have enough money set aside to fully pay off any number of expenses. A budget also helps you consider which of your expenses take precedence and should be paid off first.
A budget can be created by pen and paper, with a spreadsheet, by using an app or with other tools. It ultimately comes down to your personal preference as well as how extensive the budget is. For example, if you're calculating a large number of expenses, you might consider creating a digital budget to save time and be more efficient.
Related: Your Guide To Careers in Finance
What are the three types of budgets?
There are many types of budgets you can create whether it's for your own personal finances, your business or for the government. Here are three common types of budgets:
Also known as the master budget, the comprehensive budget is a detailed plan that helps you or your business cut back on spending. This type of budget is created in a monthly or quarterly format and plans your finances for an entire year. It aims to help you cut back on spending by setting various limits on your different spending categories. This allows you to track your spending over time and ensures that you don't overspend. A direct labor budget, manufacturing overhead budget, production budget or sales budget are just some budgets that would fall into this category. This type of budget might also include a strategy explanation or the steps needed to reach a certain budget goal.
A problem-solving budget helps you determine the areas where you're likely to overspend. Implementing this type of budget will allow you to set limits for these categories and make sure you stick to these amounts rather than overspend. In understanding where you're likely to overspend, you're better able to avoid doing so in the future. For example, let's say you tend to spend a lot of money dining out and this past month you spent nearly $200. If you know that this is a problem area for you and you're hoping to save money in the coming months, you can set a limit of $100 for this category. A problem-solving budget will allow you to see when you're nearing this amount and ensure that you don't go over.
A planning budget refers to a budget that's created to help you plan for certain events or circumstances. This type of budget is great to use when you're trying to save for a particular goal. For example, if you're wanting to plan for a new home or a vacation, you can create a new category on your budget that will help you set aside money for this expense. Before allocating money to this category, you must be paying off your most important expenses first.
Why do you need a budget?
Creating a budget is a great way to stay accountable for your spending and can help you ensure you're not spending more than you're bringing in. It's a great way to stick to your monetary goals no matter what they are. Whether you're saving money for personal reasons, trying to keep your business' expenses down or trying to pay off debts, creating a budget provides you with the ability to assess where your money is going and how to keep costs down. Here are some of the benefits of having a budget and reasons why you should create one:
Understand your spending habits
Budgeting allows you to see what expenses in your life you deem most important. Creating a budget helps you re-prioritize your spending and focus on the most essential and necessary expenses. For example, if you're creating a budget for your everyday expenses, you'll want to pay your rent or mortgage first before paying for a music streaming service. Once you've paid off your more immediate and important debts, you can see how much money you have left to allocate to your other expenditures.
Stay out of debt
Creating a budget is a great way to manage your money and stay or get out of debt. Once you know how much money you're bringing in, you can track your expenses and ensure you're not spending more than you're bringing in. By prioritizing your most important expenses, you're able to avoid unnecessary debts from accruing both now and in the future.
Relieve stress and anxiety
Without a budget, you risk becoming stressed and overwhelmed. For example, if you spent all of your income well before your rent is due, you wouldn't have enough money to cover your rent. This can cause a great deal of stress in the days leading up to your rental due date and could cause you to pay your rent late or miss the payment altogether. Once you work out a budget, you can be sure to prioritize this expense first and ensure it doesn't happen again. This can ease your nerves and give you peace of mind.
If you're hoping to save money, creating a budget will help you set aside the money you need to cover it. For example, if you're hoping to save for your wedding, you could set aside a certain amount of money per month to cover those expenses. Beings that it'll be coming out of your income, you'll need to restructure your finances to allow for the savings you're setting aside.
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