Friday, April 18, 2008

How to Save Money by Analyzing Your Budget: 4 Basic Tools

Can’t see the forest for the trees?

Budgeting is an essential part of managing our personal finances. The story doesn’t end there though. We can and should learn to leverage our budget and the historical and future data it holds. By analyzing this data we can spot trends, problems and opportunities and increase our financial efficiency.

Basic budgeting will help you keep a positive or zero cash flow, as opposed to a negative cash flow which leads to never ending debt. The next step would be analyzing a budget using basic statistical and analytical tools and trying to identify which expenditures are problematic, abnormal and hold the greatest potential for increasing savings.

#1 “I spend how much on eating out!?” or Average

The most basic tool in budgeting is arithmetical average. Since our lives are cyclical and routine by nature using average costs will work 80% of the time. Averages can be put to good use in one of two ways:

a. Analyzing average historical expenditures – Averaging historical expenditures generates the most basic from of budget data: How much, on average, do we spend on various expenditures such as groceries, restaurants, health, clothing and more. There are over 50 different monthly expenditures to include in a budget.By adding a simple average column to your budget spreadsheet you can easily get another look at how your monthly expenditures and income behaves. You’d be surprised by what you’ll find. Using averages should be limited to those cases where the expenditure is cyclical and averaging it is a good proxy. Expenditures which should not be averaged include significant one time expenses for example.

b. Using past averages to forecast future expenditures - Relying on historical averages for planning a future budget is a good way to start. Usually, cyclical expenditures will not deviate a lot from the average and would normally only need to be adjusted to inflation and increasing family size. The historical data your budget holds is priceless in planning the future.

#2 “Our grocery bill seems a bit high, doesn’t it?” or Trend

Averages are a good start but there’s more. We often use historical data to observe trends in every aspect of our lives. Why not in budgeting? Many expenditures and incomes are correlated with seasons, holidays and certain months.

Furthermore, certain expenditures evolve and show a trend. Examples are the constantly increasing telecom costs with growing internet and cellular services or growing cost of healthcare with age. There are more mundane examples such as growing food prices and more. Identifying the trend is possible by analyzing the historical data available to us in our budget spreadsheets. Isolating each expense and studying the way it behaves is easy and informative.

If changes are minor then average would be a good representative of that expense. If there is a change we can certainly characterize it as either: growth, decline or seasonal for example. This information is very useful in planning and understating our cost structures.

#3 “Holidays again!?” or Expecting the expected

Don’t you hate it when all of a sudden Christmas is here we’re tight on gift’s budget? Holidays came early this year didn’t they? Well, the expected is often very easy to forget. Another birthday, another anniversary and life goes on. Analyzing historical budget data is very useful in identifying these expenses and marking them on next year’s budget.

There is really no need to be surprised by the expected. Browse through the different months, mark the dates and the average costs each occasion generated and plan for these next year at the same time.

This goes for bigger and less frequent events as well such as weddings, college tuition and more.

#4 “I had no idea we spend 25% of our salary on groceries” or Visualization

Visualization is a very powerful tool. I wrote a post about using visualization to motivate your self to save once and I’ll press the matter a bit more.

A picture is worth a hundred words, they say. I strongly believe that. Simply taking that average expense column and generating a pie chart to display the percent each expense takes will show amazing things. 25% of our income on food is a phenomenal number and yet is very true to many families. Each expense can be controlled, some more than others, but awareness plays a very crucial part and is a pre-requisite.

Using graphs to demonstrate trends is another powerful visualization tool. An up or down trend is easily noticeable in a graph. “Unexpected” expected costs will appear as small bumps on certain months allowing you to easily identify and plan for them.

In short, our historical budget data is a goldmine for the future. Identifying opportunities and problems can be easily done if we control the right tools and put them to work properly.

Don’t be afraid to experiment with customizing your own. Playing with your budget spreadsheet will, in itself, motivate you to make the bottom line look better.

Image by Brapke

1 comment:

Sam said...

Great post. I especially like visualization as a way to see where your money is going.

For anyone who already has their budget in a speadsheet, great graphs and charts are generally just a few clicks away.

(Ignore friends or relatives who say making graphs of your budget is dorky. Budgeting is sexy.)