I believe this to be a very important part of the process. The analysis part of the process is where you can determine whether you are spending your money on your wants or your needs. This would be a good time to get your list of needs and wants and evaluate your spending habits. There are a couple ways you can do this. I will offer a couple of suggestions.
1. Graph your total monthly costs - This will give you an idea as to how well you are budgeting through out the year based on your spending needs/habits. For example, you may find that you are spending a lot of money in November and December for Christmas or you may notice more costs in June or July because of summer vacations. This is good information as this will help you plan your spending and help you be creative in budgeting in the other months so you have enough money to cover theses "wants" or "fun" expenses.
2. Graph your spending by category - I like this graph because it tells you how much in which areas you are spending your money. On this graph, you want to probably graph this by total dollars and by percentages of your total expenses. The percentages usually shine a different light on the process and help you better understand what is going on with your finances.
3. Amount you are paying yourself - Keep an eye on how much you are paying yourself. This area is really why we work so hard and to retire and retire hopefully early...right? Make sure you aren't dipping into this fun to pay other people. There has to be some relief for all your hard work. Don't let that hard work go towards paying someone else. Ensure you have enough to always pay yourself!
4. How much is your Mortgage/Rent payment eating into your budget? - This is a cost that I will discuss more later but you want to make sure you have control over your mortgage/rent payment. Make sure you aren't spending more than 28% of your gross income. This isn't something that you can change monthly so when you do lock down your payment amount, make sure you are paying less than 28% of your gross income. I guess you could change this after your payments are locked in by bringing in more money. If bringing in more money doesn't work out then in order to stay within your means I would suggest being creative with your budget. By creative I mean go through each of your categories and determine where you are spending money that may seem frivolous or you feel you are just spending too much. For example, if you are spending $400/month on entertainment then maybe you need to figure out a way to spend less in that category. Or if you are going out to eat so much that you could really be saving more if you went to the grocery store more often and cook more meals at home.
There are ratios that you can use to analyze your finances as well. Let's dive in:
1. Housing Ratio - This ratio is very nice because it give you a high level look at how well your house payment is controlling your budget. This formula can be used for both homeowners and those renting. If you are a home owner, incorporate your entire mortgage payment (principle, interest, mortgage insurance (if applicable) & property taxes). If you are renting, then only use the amount you are paying for rent. Let's say you are a homeowner and pay $1,000 a month for your mortgage. Included in that $1,000 is your principle, interest, mortgage insurance & property taxes. You have an annual salary of $60,000 so your gross monthly salary would be $5,000. The output of the ratio looks something like this:
Monthly Mortgage Payment
Housing Ratio = Gross Monthly Salary
$1,000
Housing Ratio = $5,000 = 20%
Based on this ratio, you would be in pretty good shape. Remember, you want to keep this percent south of the 28%.
2. Savings Ratio - This ratio is one that I think gets overlooked by most people. It is ratio that I believe many people think will work out on itself. This is the percentage of money you have left over at the end of the month that you can use on yourself. This is the money that will go towards a nice vacation, retirement, a new car, a new home, money to put away for that rainy day, a nice night on the town, etc. I have read books and heard financial advisors specify that this percentage should be 10% or higher if possible. Remember, Remember that you are working to pay yourself not to pay your debtors and everyone else. The ratio is pretty easy to calculate:
Net Income (amt. @ end of mth)
Saving Ratio = Net Pay (amt. you take home after taxes, insurance, etc.)
Let's run a scenario. You bring home $4,000 after taxes, insurance, etc. You have net income of $450 at the end of the month.
$450
Savings Ratio = $4,000 = 11.25%
This is where you want to be at and then some. Keep an eye on this ratio and figure out how you can optimize it.
Use this ratio to help manage your expenses and when putting together your budget. As you become familiar with this ratio you can be creative with your budget. With this ratio you can:
A. Run What-If Scenarios - put in different amounts for your income or other expense categories to get an idea of how much you would need to make to save at least 10% at the end of each month
B. Salary Negotiation - I will get into salary talk later but as you put in different salary amounts, you can get a taste for how much you need to earn to save that magical 10% or more on a monthly basis.
C. Debt Reduction - If you are carrying any type of debt: student loans, credit cards, car, home, frivious purchases, anything, run a scenario to see how much you would be making if you didn't have to pay off your debtors. In this scenario, I am suggesting you pay off your debts as fast as you can so you can have a strong credit score, pay as little interest as possible, and enjoy a "raise" as you will now have liberated yourself from financial bondage. Now once that debt is paid off, don't get back into debt. Be Wise and Spend Wisely!
The above scenarios work and they will give wonderful perspective into how much you can enjoy life while only working hard at work and eliminating the stress of paying off debt or spending your money unwisely.
3. Debt-to-Income Ratio - Many of you many be familiar with this ratio, especially if you own a home. This is a ratio that lenders use to determine whether or not you qualify for a mortgage. This ratio takes all your monthly debt payments and determines how much of your income is going towards paying down your debt. This is one percentage you want to be low. This will take your monthly credit card payments, student loan payments, car payments, mortgage/rent payments, etc. Let's run a scenario. You have a $100 student loan payment, $350 car payment, $1,000 mortgage payment, and a $600 credit card payment. Your total monthly debt payments are $2,050. You bring home $5,000 a month. What is your debt-to-income ratio:
Total Mthly Debt Pmt's
Debt-to-Income = Monthly Gross Pay (Amt. before taxes, insurance, etc.)
$2,050
Debt-to-Income = $5,000 = 41.00%
It is said that with a debt-to-income of over 55%, you shouldn't qualify for a mortgage. Keep an eye on this as well. Don't drown yourself in debt. It is good to have some breathing room.
Cheers to budgeting and owning your finances!
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