Why Is a Personal Budget Important?

Personal budgets, or spending plans, are tools that can help you to meet your financial goals. The process of building a budget can help you to take a hard look at your priorities and to determine whether you're on track to reaching your financial goals.

A budget is a listing of expenses and income. As Dorothy Rosen of Bankrate.com explains, "An actual budget is simply the amounts that currently come in and go out; a projected budget is an expectation of future ins and outs." She advocates putting it all down in writing, further pointing out, "... it's that 'in writing' part that separates the financially savvy adult from the clueless masses."

Listing anticipated income and expenses allows for prioritization of expenses like making mortgage and car loan payments before spending money on entertainment. A projected budget provides a framework for making decisions about expenses, such as canceling premium movie channels to put the money toward a new car. An actual budget allows you to monitor how close you are to your goals. This knowledge can help you to create budget plans that mesh with your daily habits.

Budgets can be as high-tech as a sophisticated computer program or as simple as a pencil and paper list. Software packages like Intuit's Quicken can use past spending patterns to project future expenses and then track actual spending against plans as expenses are entered. Spreadsheets like Microsoft Excel can also be used for both planning and tracking. For the pencil and paper version, most office supply stores carry accounting forms and budgeting forms. There are online services, that can also help with the process.

Financial literacy programs, like the FDICs' Money Smart, use the budget to set financial goals. Goals that excite and inspire will help you stay on your spending plan. Once the goals are set--like home ownership or retirement savings, the monthly savings required is entered into the budget. By making savings plans a part of each month's expenses, Money Smart advocates "paying yourself first," or depositing your money in a savings account before other expenses reduce it.

Tracking spending habits paves the way to identify ways to decrease expenses. Monthly tracking can help you to look at the true cost of small and large expenditures, and to decide whether a daily latte is more important than other financial goals. Often, the act of annualizing an expense (multiplying a daily expense by 365, a weekly expense by 52 or a monthly expense by 12) can provide insight in to the true cost of your habits. Ranking expenses in descending order highlights the relative importance of each expense, the items at the top should reflect your highest priorities.

In an ideal world, your income would always exceed your expenses, and you could use a budget to decide what to do with the excess money. In some cases, decreasing expenses isn't an option or doesn't cover the gap when the budget shows monthly spending exceeding monthly income. As the Motley Fool's Dayana Yochim puts it, "remember this one simple budgeting rule: Spend less money than you make." If spending less isn't an option, then consider working additional hours, taking a part-time job or having other members of the household contribute income to bring your budget into balance and to help you to get back to achieving your financial goals.