Budgeting is the systematic process of preparing detailed short term plan of actions expressed in monetary values.
The plan quantified in monetary terms prepared ahead of a defined period should show expected income and expected expenditure.
A budget should also fulfill a planning purpose and a control purpose (underlined by the comparison of actual result to budgeted).
A negative variance occurs when actual results are more than budgeted. To avoid this, the budgeting process must separate ‘wants’ from ‘needs’.
What are wants?
Wants are not needed for survival.
They are those things we would like to have but we can do without them (wants are things we don’t require them).
Examples of wants are high end cell phones, expensive cars, expensive shoes, travel, social media subscriptions, entertainment etc.
What are needs?
Needs are what we require to survive.
Examples of needs are food, shelter, water, medication, clothing and transportation.
Why is the distinction between wants and needs important to effective budgeting and budgetary control?
A lot of people hardly live within their budgets. So many people consistently overshoot their budgets because they spend more money on things they want and spend very little on their needs.
The consequences are the inability to consistently save a portion of their income to provide for themselves sufficient food, a home and improved net worth. And a recurring negative variance.
To solve this problem, the next time you prepare your personal budget, write down your wants, your needs and apportion monetary values to all of them.
Keep in mind to regularly update your need and want lists. The reason is, some things you consider wants today may become needs tomorrow.
Don’t forget that the whole essence of making the distinction is to help you save money, invest and grow financially.