In this article, we will explore what a balanced budget is and how to create one. We will also discuss the importance of a balanced budget and its benefits, as well as how it works and its role in the U.S. government.
Definition and Examples of a Balanced Budget
A balanced budget refers to a spending plan where your expenses are less than or equal to your income. In other words, a balanced budget demonstrates whether you are living within your means.
Example: If your annual income is $75,000 and you are spending only $70,000, then you have a balanced budget, as your expenses are equal to or less than your income. In this case, you can use the extra money in the budget to pay off debts or achieve your savings goals.
On the flip side, if you are spending $80,000 a year, you will have an unbalanced budget because you are spending more than you earn. In this scenario, you are likely to accumulate debt to maintain your current standard of living.
How Does a Balanced Budget Work?
A balanced budget is an essential part of financial stability as it helps you avoid debt and achieve your savings goals.
If you spend more than you earn, you will have a budget deficit. After that, you will have to borrow money from elsewhere—such as a credit card or a loan—to make up the gap. This increases your debt. If your debt becomes too large, it could create a significant disruption in your financial security.
When you have money left over after covering all your expenses, this is called a budget surplus. This is a good thing because it means you are living within your means and not accumulating debt to finance your lifestyle.
Here are three budgeting examples to illustrate these concepts:
Balanced Budget with Equal Income and Expenses
- Starting Income: $3,000
- Living Expenses: $1,750
- Debt Repayment: $500
- Wants (shopping, dining out, travel, etc.): $750
- Remaining Balance: $0
In this scenario, your income minus all your expenses equals $0. This is great news because it means your budget is balanced and you are not spending more than you earn.
But do you notice the problem in this budget? You have no leftover money to fund your savings goals. Plus, you have a lot of debt to repay, but no extra funds to meet those financial obligations.
Balanced Budget with Surplus
- Starting Income: $3,000
- Living Expenses: $1,500
- Debt Repayment: $550
- Wants (shopping, dining out, travel, etc.): $500
- Remaining Balance: $450
In this example, you have the ideal balanced budget—your expenses are less than your income, and there is extra money for savings goals.
You can take this extra $450 and use it to build your emergency fund, save for your child’s education costs, increase your retirement savings, or set aside a down payment for a home.
Unbalanced Budget
- Starting Income: $3,000
- Living Expenses: $2,000
- Debt Repayment: $600
- Wants (shopping, dining out, travel, etc.): $600
- Remaining Balance: -$200
In this scenario, you are spending more money than you earn. You are accumulating more debt each month and feeling significant pressure regarding your finances. But the good news is that by comparing your income to your expenses, you now have a clearer view of where you can cut spending. Consider reducing unnecessary expenses or adding a part-time job to meet necessities.
The Benefits of a Balanced Budget
The main benefit of a balanced budget is that it prevents you from borrowing. It can help you stop overspending and highlight pressure points in spending, increasing income, and saving more money.
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If you live paycheck to paycheck or struggle to meet a proper budget, creating a balanced budget can help you identify potential weaknesses. As a result, you’ll feel more in control of your finances and be in a better position to tackle your financial goals.
Note: While a balanced budget can be helpful, it may not be achievable for households that consistently spend more than they earn due to low wages and other factors. In this case, meeting with a free financial advisor and obtaining the tools you need to improve your financial situation can be beneficial.
How to Create a Balanced Budget
A balanced budget is simply comparing your income with your expenses to ensure both align. Here’s how to do that:
1. Add Up Your Income
Review your monthly income to see how much money you’ve brought in. This can include money from work, side jobs, financial aid, social security, alimony, or any other revenue.
If your income fluctuates, look at how much money you made last year and divide it by 12 to get a monthly estimate.
2. Estimate Your Expenses
Now it’s time to estimate your monthly expenses. Review your bank and credit card statements to identify items such as housing costs, vehicle expenses, food, insurance, etc. Some of these costs will remain constant each month (“fixed”), while others may change each month (“variable”). Make your best estimate for the amount of expenses in each category every month.
Note: When tallying your purchases, don’t forget to include any unusual expenses such as home insurance paid twice a year, oil changes, Christmas gifts, and other irregular purchases.
3. See Where You Stand
At this step, all you need to do is subtract your expenses from your income to see if you have a positive or negative number.
If your balance is positive, you’re spending less than you earn. You can take this extra money and use it to build your emergency fund, pay off debt, invest in your future, or cover upcoming holiday-related financial expenses or any other goals you wish to achieve.
If the balance is negative, you’re spending more than you earn each month and operating at a deficit. To get back on track and balance your budget, look for ways to reduce expenses and/or increase your income.
Note: You no longer have to manually keep a balanced budget on your own. Thanks to technology, you can use a budgeting app or spreadsheet to streamline the process and save time and effort. Many banks also offer built-in budgeting tools to help you save money and maintain control over spending.
The U.S. Government and Balanced Budgets
In the United States, a government balanced budget occurs when the funds the country spends (on healthcare, social security, infrastructure, federal debt interest, etc.) equal the funds it collects (through taxes and other means) for the fiscal year.
A balanced budget is important because it helps maintain a healthy economy. However, in reality, it is difficult for countries to maintain a perfectly balanced budget, as they usually operate in surplus or deficit.
The United States has had 12 balanced budgets since 1947. The last year the United States had a balanced budget was 2001.
Source: https://www.thebalancemoney.com/what-is-a-balanced-budget-5215527
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