What is a budget?

The budget is the primary tool through which financial plans are put into practice. It is a quantitative plan for a specific period of time or for a particular purpose (funding an activity, event, goal, etc.). It connects the objectives a person strives for with the resources they have. This helps prioritise and consequently arrange these goals and set them within a time frame. A budget should clearly reflect any changes in income and expenses, which means that financial plans must be updated accordingly - better circumstances, for example, may allow for faster achievement of the desired goal.

On the one hand, budgets support the fulfilment of short-term goals - such as ensuring that the money you spend does not exceed what you have (i.e., the aim is to ensure your survival). This is because some expenses in a budget are difficult to influence or limit - such as rent payments, utilities (water, electricity, heating), food and clothes, phone and internet bills, loan instalments, insurance, etc.

At the same time, every long-term goal you set is reflected in the budget. If you aim to accumulate capital for a down payment on a home or car, you will allocate a portion of your income over a set period of time. This will limit your available funds in the present, meaning that by saving, you defer current consumption for the future. Here, the budget helps determine how much of your income you can set aside relative to necessary expenses and the timeframe within which you aim to achieve your goal.

 

What is an opportunity cost?

When prioritising within your budget, you inevitably encounter opportunity costs. This abstract concept represents the second-best alternative - the one you give up in favour of your primary choice. Imagine you have a limited amount of money, just enough to cover everything on your shopping list. However, upon arrival at the store, you see that a product you need - but usually cannot afford - is available at a discounted price. To buy it, you must forgo something else from your list. The item you give up is the opportunity cost of your new purchase. It is not the price you pay but rather the item you forgo - along with the potential negative consequences of not buying it. That is why, budgets help manage opportunity costs better, which you encounter on a daily basis, as resources are limited. In these situations, you sacrifice various desireswhich are not essential for survival - such as designer clothing, dining out, expensive gadgets, exotic vacations, etc. Instead, you opt for more affordable alternatives, ensuring that you set aside funds for more important long-term goals.

 

What types of budgets are created?

Budgets cover both short-term and long-term financial goals - ranging from building an "emergency" fund, to sustaining yourself without income for a certain period, to investing monthly for retirement or leaving an inheritance for your heirs.

Budgets can be created based on different timeframes, depending on how often you receive income - for example, weekly, monthly, or twice monthly (such as receiving an advance and final salary payment). They can be regular or aimed at a specific goal - such as a budget for a particular event, like an overseas trip, a wedding celebration, or home renovations. In such cases, all necessary expenses and available financial sources must be listed. In addition to current income, these sources may include savings from previous periods or, in some cases, borrowed funds.

Various types of budgets exist. The most common is the cash flow budget, which tracks cash flow movement (inflows and outflows of money). This budget details expected income during a specific period (incoming cash flow) and anticipated expenses (outgoing cash flow). It is essential because it helps manage savings and determine the potential need to borrow funds.

• Inflows and Outflows

Inflows and outflows of money differ from income and expenses. For example, imagine you work at a company that pays salaries by the 25th of the current month (e.g., December). In the following month, you switch jobs, and your new employer pays salaries on the 10th of the next month (e.g., February). This means that in January, you will not receive any income and will have to cover a 45-day period instead of the standard 30 days with your December salary. Your January salary is considered income for that month, but you will receive the actual payment in February.

When you invest money, you make a payment, but this is not a real expense since you can always convert the investment back into cash. Investments also generate returns - either through interest or an increase in value. However, you typically receive investment proceeds at the end of the investment period (upon maturity) or when selling the asset. A similar situation occurs when you pay a security deposit for renting a car or an apartment. You need cash now to make the payment, but the deposit is refunded later, meaning it is not a real expense that reduces your total available funds. While advance payments (such as a down payment) are deducted from the final amount owed, deposits serve as guarantees for covering potential damages or additional costs. Before refunding the deposit, the landlord or rental company may deduct unpaid utility bills, repair costs for damaged property, traffic fines, etc.

·         Income and Expenses

Unlike inflows and outflows, income and expenses impact your personal financial well-being - your wealth. For example, when you take out a loan, neither the funds received nor the loan repayments directly make you richer or poorer. You merely shift your own money through time - spending now what you would otherwise earn in the future (opposite of saving). However, the interest you pay on the loan is a real expense that decreases your wealth. To measure this, one creates a budget of the so-called net assets, which is the difference between the total value of everything you own and everything you owe.

·         Net Assets

If you finance a car purchase through a lease, your wealth equals the car's current market value minus the total amount owed on the lease. This can often be negative since vehicles as assets depreciate rapidly. The same applies to buying a property with a mortgage. For this reason, lenders require a certain amount of personal capital (down payment) to ensure positive net worth - so that selling the asset will generate enough revenue to cover your remaining debt. A net asset budget helps manage overall indebtedness and prevents situations where your debts exceed your assets.

 

TIP: When creating your budget, "pay yourself first", record your income and expenses regularly and track them regularly, which will help you adjust your budget if necessary. In order to simplify the management of your finances, you can use a suitable budgeting app.