The difference between budgeting and accounting

Budgeting is the act of making a plan for where money should go before you spend it. It is preemptive accounting, accounting being the keeping of records on where money went after it was spent. The budget should, at minimum, put a target limit on all spending categories for a fixed period of time but it does not need to predict any yellow arrow transactions and it typically does not include green arrow transactions. Budgets are a tool for controlling spending so they need to address spending categories.

A useful budget must be designed by the following criteria:

• It must be specific by category. “I’ll spend less this month” is not a budget. “I’ll spend no more than $300 on groceries, $1000 on housing... etc” is a budget.
• When designing a budget, it must coincide with the categories tracked in your accounting software. If you have an entertainment account category, it needs a budget; if entertainment is part of your miscellaneous, then entertainment should not have a line item in the budget.
• It must be grounded in reality. “I’ll spend no more than $2 on food this month” is not a realistic budget unless an employer is providing food as part of the compensation. As it is drafted, it must be compared to the previous time period’s real spending and the previous time period’s budget. Unless of course it is your first month pulling your financial life together and you have no records.
• It must first cover basic living expenses, then an appreciable savings rate, and only then allow for frivolous luxuries.
• It must be written down so that it can be referenced as purchasing decisions are made thereby preventing overspending by optimistically recalling the budget from memory as a decision is made. The written record should also be used the following month to draft the next budget.

Budgets are a tool for financial beginners struggling with self-control. Those who cannot seem to help but run their financial lives off a cliff without thinking ahead need to budget. If you are saving more than 25% of your income without a budget (as recorded year by year with real records and not a silly guess), you can live just fine without a budget. Everyone else should have a budget that they stick to religiously.

By far my favorite anecdote about budgeting and accounting illustrates the point that a person who is not coming to appropriate conclusions is a person who does not have a complete set of facts. Dave Ramsey described the largest fight of his marriage over their first budget as a disagreement about groceries, him thinking $500/mo was ridiculously high, and Sharon his wife saying it was conservative and he did not know what anything cost. He went to the grocery store to prove her wrong but lo and behold, she was right and once confronted with solving the problem in reality rather than in theory (otherwise known as “in Dave’s imagination”), Dave came around to the same conclusion his wife had.