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Budgets

Ratio, rates and money · level 4, lesson 6 of 6

A question to start

Maya is 16 and works weekends at a garden centre. She earns about 480 dollars a month. That sounds like plenty. Yet by the end of every month her bank account is almost empty, and she cannot say where the money went. A bus pass here, lunch with friends there, a new phone case, a birthday present...

Here is a small fact that surprises many people: a 4.50 dollar snack every school day adds up to about 90 dollars a month, and about 900 dollars over a school year. Little amounts, repeated, become big amounts. That is rate thinking again.

How can Maya take charge of her money, so that she knows where it goes and can save for something she really wants? The tool is a monthly budget. Families, students, businesses and whole countries all use the same idea.

The idea

Income and expenses

  • Income is money coming in: pay from a job, an allowance, gifts.
  • Expenses are money going out: everything you spend.

For a month, the key number is

\[\text{income} - \text{expenses}.\]

If it is positive, you have a surplus (money left over). If it is negative, you have a deficit: you spent more than came in, so the difference came from savings, or from borrowing. A budget balances when expenses are no more than income.

For people with jobs, the income to plan with is take-home pay: what is actually paid into your account after income tax and other amounts are taken off your pay. That is the money you can spend.

Fixed and variable costs

Expenses come in two kinds.

  • Fixed costs are the same every month: rent, a phone plan, a bus pass, an insurance payment. You know them in advance, and they are hard to change quickly.
  • Variable costs change from month to month: groceries, eating out, clothes, entertainment, gas for the car. You have more control over them, day by day.

When a budget does not balance, the quickest place to look is usually the variable costs. Fixed costs can be cut too, but it takes a decision (a cheaper phone plan, a smaller apartment).

Costs that are not monthly

Some costs come once a year or a few times a year: birthday presents, a school trip, car insurance paid yearly. A good budget turns them into a monthly rate so they do not come as a shock. If you spend about 240 dollars a year on presents, that is \(240 \div 12 = 20\) dollars a month to put aside.

Maya's budget

Here is the budget Maya made after tracking her spending for a month.

Item Kind Per month (dollars) Percent of income
Income Garden centre pay (take-home) 480 100%
Expenses Phone plan fixed 35 7.3%
Bus pass fixed 60 12.5%
Lunches and snacks variable 120 25.0%
Movies, games, outings variable 80 16.7%
Clothes variable 50 10.4%
Presents (240 a year) variable 20 4.2%
Savings 100 20.8%
Total out 465 96.9%
Left over 15 3.1%

Each percent is "one amount as a percent of another" from lesson 3: the item divided by the income, times 100. The percents show how big each part of the budget is, which raw dollars hide.

fixed variable spending savings 95 (about 20%) 270 (about 56%) 100 (about 21%) left over 15 (about 3%) income 480 dollars = 100%

Seeing the numbers, Maya notices that lunches and snacks take a quarter of her income. That is the 4.50 dollar snack habit at work.

Saving first

Notice that savings is a line in the budget, not "whatever is left at the end". Many people find that if they wait to see what is left, nothing is. Putting the savings aside first, on payday, is sometimes called "paying yourself first". It turns saving into a fixed cost.

A savings line also answers "how long until I can afford it?" If Maya saves 100 dollars a month for a 750 dollar laptop, plus 13% tax, she needs \(750 \times 1.13 = 847.50\) dollars. That takes \(847.50 \div 100 = 8.475\) months, so 9 months (rounding up, since 8 months is not quite enough).

A rule of thumb

One popular guideline splits take-home income into three parts:

  • about 50% for needs (housing, food, transport, bills),
  • about 30% for wants (fun, eating out, extras),
  • about 20% for savings.

It is a rule of thumb, not a law. A student living at home may save far more than 20%; a family in an expensive city may need much more than 50% for needs. But it is a useful first check.

When the budget does not balance

There are only three ways to fix a deficit:

  1. Spend less on variable costs: cook instead of eating out, borrow instead of buy.
  2. Cut a fixed cost: a cheaper plan, cancelling a membership you do not use.
  3. Earn more: more hours, a second source of income.

Borrowing to cover a deficit only moves the problem to next month, with interest added. Credit and interest come later, in level 6.

Worked examples

1. Is Maya's budget balanced? Income 480, total out \(35 + 60 + 120 + 80 + 50 + 20 + 100 = 465\) dollars. Left over: \(480 - 465 = 15\) dollars. Yes, it balances with a small surplus, and she saves 100 dollars, which is \(100 \div 480 \approx 20.8\%\) of her income.

2. A family budget that does not balance. A family's monthly take-home pay is 5200 dollars. Their plan:

Item Kind Dollars
Rent fixed 1900
Electricity, heat, water mostly fixed 250
Groceries variable 900
Car payment, gas, transit mixed 650
Phone and internet fixed 180
Child care fixed 600
Insurance fixed 150
Eating out and fun variable 400
Clothing variable 150
Savings 300
Total 5480

That is \(5480 - 5200 = 280\) dollars over. One way to fix it:

  • eating out and fun from 400 down to 250 (saves 150);
  • groceries from 900 to 820 by planning meals (saves 80);
  • a cheaper phone and internet plan, from 180 to 130 (saves 50).

Savings: \(150 + 80 + 50 = 280\) dollars. Now the budget balances exactly, and they still save 300 dollars a month. Other fixes are possible; the math tells you whether a fix is big enough.

3. Turning yearly costs into monthly. A family pays 1200 dollars a year for car insurance and expects a 180 dollar school trip in 6 months.

  • Insurance: \(1200 \div 12 = 100\) dollars a month.
  • School trip: \(180 \div 6 = 30\) dollars a month for the next 6 months.

4. Using the 50/30/20 guide. Maya's take-home pay is 480 dollars.

  • Needs: 50% of 480 is 240 dollars.
  • Wants: 30% of 480 is 144 dollars.
  • Savings: 20% of 480 is 96 dollars.

Her actual savings, 100 dollars, are a bit more than the 20% guide.

5. A small habit. A 4.50 dollar snack every school day, 5 days a week, about 4 weeks a month:

  • Per month: \(4.50 \times 5 \times 4 = 90\) dollars.
  • Per school year of about 10 months: \(90 \times 10 = 900\) dollars.

Try it

  1. A student's income is 300 dollars a month and her expenses are 275 dollars. Is there a surplus or a deficit, and how much?
  2. Sort these into fixed or variable: rent, groceries, phone plan, gas for the car, gym membership, eating out.
  3. Home insurance costs 600 dollars a year. How much should be put aside each month?
  4. Ben earns 360 dollars a month and wants to save 15% of it. How much is that?
  5. Using the 50/30/20 guide, how would you split a take-home income of 2400 dollars a month?
  6. How many months does it take to save 500 dollars at 60 dollars a month?
  7. A coffee costs 3.75 dollars and someone buys one on each of 22 work days a month. What does that cost per month and per year?
  8. A budget is 120 dollars over. The person can cut eating out by 70 dollars, switch phone plans to save 25 dollars, or cancel a 40 dollar gym membership. Which two of these together are enough? Is any one enough by itself?
Answers
  1. \(300 - 275 = 25\), a surplus of 25 dollars.
  2. Fixed: rent, phone plan, gym membership. Variable: groceries, gas for the car, eating out.
  3. \(600 \div 12 = 50\) dollars a month.
  4. 10% of 360 is 36 and 5% is 18, so 15% is \(36 + 18 = 54\) dollars.
  5. Needs: 50% is 1200 dollars. Wants: 30% is 720 dollars. Savings: 20% is 480 dollars. (Check: \(1200 + 720 + 480 = 2400\).)
  6. \(500 \div 60 \approx 8.33\), so 9 months (after 8 months there are only 480 dollars).
  7. Per month: \(3.75 \times 22 = 82.50\) dollars. Per year: \(82.50 \times 12 = 990\) dollars.
  8. No single change is enough (the biggest is 70). Pairs: eating out and phone save \(70 + 25 = 95\) (not enough); eating out and gym save \(70 + 40 = 110\) (not enough); phone and gym save \(25 + 40 = 65\) (not enough). No pair is enough! All three together save \(70 + 25 + 40 = 135\) dollars, which fixes it with 15 dollars to spare. (Sometimes the honest answer is "you need all of them, or a bigger change".)

Common mistake

Budgeting with pay before deductions. If a job pays 600 dollars but 60 dollars are taken off for tax and other deductions, the budget must use 540 dollars. Plan with what actually arrives.

Leaving out the irregular costs. A budget that forgets yearly and once-in-a-while costs looks balanced until the month the insurance bill or a birthday arrives. Turn them into monthly amounts and include them.

Where it leads