Your household budget: aspects to take note of

There is focus on and attention around the Union Budget. While it is relevant, it impacts your personal finances at the margin. What impacts you more is your own budget. It is useful to have a discussion around your household budget — it may point to details you might be missing.

It starts with the heads of income. Receipts from various sources have to be listed and this becomes total income. Some of these would be regular in nature while there might be heads like investment income that is not regular and comes as and when. Then comes the expenses side. On the expense side, there are some amounts that have to be compulsorily spent, called mandatory expenses. Loan equated monthly expenses (EMIs) and provident fund contributions are examples of such mandatory expenses. 

Others are essential living expenses, necessary for daily life. Finally comes the discretionary expenses — ones that are not essential to your daily living and can be cut in case there is a need for a control on the total amount spent. Total expenses, when reduced from total income, gives the savings managed by the household. 

In some cases, there is only a single family member earning, while in other families, there could be more than one earning family member.

The income of a household or individual has to be adequate to meet the current expenses as well as provide savings to create assets that will help meet future expenses. If the current expenses are controlled, then it contributes to securing the financial future of the household. Judicious financial management requires a defined level of savings that should be targeted, which is essential to meet future financial goals. A budget helps a household plan its income and expenses so that the income available is utilised in an optimum manner to meet current and future needs. requirements. Once the incomes and expenses are identified and listed, it will be easy to assess where the problem lies, if the savings are inadequate. 

While income cannot be expanded beyond a certain level, the focus should be on managing expenses to enhance savings.

Monitoring budget

Monitoring the budget involves recording actual income and expenses, which shows the real situation of the household or the individual. It has a vital role to play in financial decision making. The actual figures compared with the budget plan will give an idea of how robust the budget planning was. 

Monitoring of the budget has to be done continuously, and after looking at the difference between the budget and the actual, action needs to be taken. This action has to be in the form of correcting the budget figures going ahead. 

If there is an area where the budget target is constantly missed, then the planning is off track and that needs to be corrected. For example, if there is a provision of ₹5,000 a month for conveyance and the average conveyance expense comes to say ₹8,000 for consecutive months, then it is either the budget figure that has to be changed or the individual has to change the mode of conveyance to reduce cost.

The amount of savings that is consistently achieved has to be seen in light of future financial goals. For example, a family saving ₹20,000 a month may require savings of ₹40,000 per month to match future goals. The budget and its monitoring will also give a direction about the steps to be taken so that the savings can rise and reach the desired level. In general, a target of raising the savings rate by a specified percentage might be set. This could be something like 10% which is not too difficult to achieve.

Personal balance sheet

Preparing a personal balance sheet and net-worth computation gives a perspective on where you stand. A balance sheet shows the financial position of the individual or household in the form of assets and liabilities on a particular date. Things can change after that date and the balance sheet will also change, but it is important to see how things are stacked up at a particular time. Assets for an individual include physical assets like property, car etc. and financial assets like bank balance and investments in equity, mutual funds, etc. Loans are a liability and reduces your net worth to that extent, against your assets.

Assessment of the financial well-being of a household/individual can be made by calculating the net worth, which is calculated as assets minus liabilities. 

The higher the number, the better the financial position. Net worth should be calculated periodically, and progress should be tracked to bring the financial situation to the desired stage.

Contingency planning is another important aspect. Contingencies could be sudden medical expenses or if something were to happen to the only earning member of the family. Separation (divorce) is another risk that families face. In developed countries, the wealthy go in for pre-nuptial agreements. This is an agreement, entered into before marriage, which details how the finances (and any other matter) will be dealt with, in the event of a separation. An emergency fund needs to be the first goal towards which a household or individual should save, as a protection against the possibility of loss or reduction of income. The fund should be adequate to meet the expenses for, say, six months, in the event the regular income is not available. Insurance is important, but also important to note for protection, you need term insurance. Term insurance is pure protection, there is no need to club it with unit linked savings plan (ULIP) or traditional/conventional insurance products.

To conclude, savings ratio is the percentage of income an individual/household is able to save. If your income is ₹100 and you are saving ₹20, your savings ratio is 20%. 

Obviously, the higher the better. There is a counter argument as well, that you need to enjoy your present and not just save for the future. There is another relevant ratio here, that is debt servicing ratio.

If your net-of-tax income is ₹100 and you spend ₹40 in servicing EMIs, then debt-service ratio is 40%. You have to strike a balance between being prudent and managing a savings ratio of 20 to 40% or enjoying your present well extremely and getting into a debt trap of EMIs later.

(Joydeep Sen is a corporate trainer on financial markets and an author.)