Why Planning & Budgeting is Critical to Becoming Financially Free

I can still remember my first lecture in Management Accounting. The lecturer was introducing us to the concept of budgeting and at the end he made a little joke, which went something like this: "If your budget has turned out exactly right, you have either had an amazing stroke of luck or got it wrong!" Of course, what he meant was: budgets are not meant to be accurate. They are there as a guide - an important, essential guide that should act as both a planning and control mechanism.

I try to avoid the word budget with my new clients but I would like to introduce you to the real meaning of budgeting. Forget about the concept of restriction and restraint often associated with household budgets and start thinking about your finances in the same way that good businesses do.

The glue that holds all successful business practices together is the master budget. It ties in all facets of the business - marketing, selling, financing, research and development, and personnel management. Without a good master budget that incorporates all activities of a business, an organisation will end up floundering. And a floundering business is rarely profitable.

The budget provides the cohesion between the differing objectives of diverse parts of the business and creates a unified goal for the total organisation to work towards. It enhances motivation, delegates responsibility and provides important feedback on the progress of individuals and the organisation as a whole. Not bad, for a simple system that we all thought someone installed to punish us for our mistakes.

Budgets are not punishment. They are important, useful tools that guide us to where we want to go. They allow us to plan for our future yet control our circumstances along the way. They are not meant to be exact, but rather flexible and accommodating. They should change when we change, but still be resilient enough to prevent us from going off the rails. They point us in the right direction and correct us when we fail. Without a budget for our finances, we are trying to win the 100-yard dash blindfolded.

People make mistakes. We have human weaknesses that cannot always be perfected. As good as our judgement may be, there are times when we can go off course. We can be tempted, we can be deluded and sometimes we just slip up. What we need is something that keeps us on the right road without invalidating our past mistakes yet motivates us to try again. And again, and again - until we get it right.

I have had clients who tried but left after a couple of weeks, only to return to me months or even a year later, "Sorry, can we try again?" Sure. It took me a couple of years to perfect it. Sometimes, I left it for weeks or even months, returning to my old spendthrift ways, but eventually came back with a greater knowing that the only way I could get ahead is to work within the system.

A good system will allow you to do this. This is called "Correction, without Invalidation." In other words, keep trying and correcting your mistakes without making them wrong.

What we need is a system that allows us to deviate off course at times but builds in controls to prompt us back whenever we veer too far - a system that facilitates correction, without invalidating the mistakes we made on the way.

First, you need a plan. A plan incorporates objectives, goals and step-by-step strategies or action plans. An objective is a high-level, qualitative statement describing a desired outcome. For example:

"To be financially independent and free to travel the world."

A goal is a quantifiable statement that is measurable and specific. For example:

"To create an independent income of $30,000 per annum, so I can leave my current employment by by a certain date."

The action plan then becomes your step-by-step approach of how you can create the independent income by that date.

If your objective is your life's dream - to travel the world - then the sacrifice of saving will not seem so daunting. We are all willing to make small sacrifices over time, if we have a greater goal in mind.

Another critical aspect of budgeting is comparison. We need to always compare what happened to what was supposed to happen. If you have a budget but never go to the trouble of comparing your actual expenditure to the budget, you are only using 50% of the system.

It is important that on a regular basis you compare your actual expenditure and outgoings to what was budgeted. Use the variances as a feedback mechanism to gauge your progress. It is OK to have variances. Remember the immortal words of my Management Accounting lecturer - budgets are not meant to be exact, they are used as a guide.

The variances will tell you how you fared. Was your budget realistic? Did you under-budget? Over-budget? If the budget is unrealistic, modify it. Budgets should be dynamic tools, changing where necessary until you get the right mix.

Did you overspend? Underspend? Was the budget reasonable but you simply broke the rules and fell back into bad habits? That's OK, the variances will guide you to where you need to focus your attention.

Did you waste too much money at the supermarket? Spend too much on discretionary items? Are your fixed costs still too high? Correction. Correction. Correction. The variances will show you where.