You already have your expenses organized into spending categories; you now can break them down further into fixed expenses and variable expenses, and nondiscretionary expenses and discretionary expenses. When you have all your expenses categorized, it will be easier to see how you can control your budget. Analyzing different ratios within your budget will also help you determine where you should be cutting back your expenses.
Some of your expenses are fixed and others are variable. Fixed expenses include the following:
- Car payments
- Any other payments that don't vary in amount, such as dues or club membership fees
- Your mortgage, if you have one
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Talk about picky! You can break down your expenses into fixed expenses, such as rent and car payments, and variable expenses, such as food and entertainment. Don't stop yet! These categories can be further broken down into nondiscretionary expenses, which are things you can't do without, such as food and rent, and discretionary expenses, which you can do without (vacations and entertainment).
While these expenses may be necessary, like rent or mortgage payments, they often can be scaled down. If your rent is more than you can afford, you might have to move to a smaller place or get a roommate. Or perhaps you could refinance your mortgage for a lower interest rate (be sure to consider the expenses involved in refinancing before deciding to go ahead). You may really like the club you've joined, but if the membership fees are too high, you may have to consider dropping out. Still, fixed expenses are not the easiest ones to scrimp on. Let's take a look at the variable expenses.
Variable expenses include the following:
It's probably easier to cut back on variable expenses such as these than on fixed ex-penses. Utilities can be adjusted to save money, and you can pass up the lobster tails and eat chicken instead. After you break down your expenses into variable or fixed, you can add another category: discretionary or nondiscretionary. Nondiscretionary expenses are things you must pay for or buy, including the following:
- Rent or mortgage
- Car payments
Nondiscretionary expenses can't be avoided, but you might be able to control them, as discussed earlier. Discretionary expenses, on the other hand, are those that aren't necessary, including the following:
- Club memberships
These discretionary expenses are the most obvious ones to curtail if you're trying to cut back on expenses.
Now you can organize your expenses by how they fit into both sets of categories. The following are fixed, nondiscretionary expenses:
- Rent or mortgage
- Car payments
Variable, nondiscretionary expenses are as follows:
Your fixed, discretionary expenses include the following:
- Club dues
- Membership fees
Your variable, discretionary expenses include the following:
Basically, there are two ways to use this information to save money: You can control your discretionary expenses (skip the vacation this year), or limit your nondiscretionary expenses (find a roommate or move into a smaller apartment).
When it comes to figuring out where you need to cut expenses, you'll find spending ratios to be useful tools. A spending ratio is simply the percentage of money, as it relates to your gross income, that you use for a particular area, such as housing or entertainment. If one area of expense becomes too great, you'll see that ratio is too high and begin to cut back.
To figure out your housing payment ratio, which is one kind of spending ratio, add up all your housing costs (rent or mortgage, insurance, property taxes, and so on). Compare that number to your total income. If your housing costs are more than 28 percent of your gross income, you're paying too much for housing and should look for ways to cut your costs.
Spending ratios are used to determine the amount of your gross income that goes toward a particular expenditure area. They can be used as tools in cutting expenses. Your savings ratio is the opposite of your spending ratio. It is the percentage of your gross income that you are able to save within a given time.
To figure your total debt ratio, add up all your monthly payments, including car, credit card, rent, and so on. Compare that number to your total income. If it's more than 36 percent of your income, these ex-penses are too high, and you should look for ways to cut them.
Finally, you can figure out your savings ratio, which is the percentage of your gross income that you save. Compare the amount of money you save each week or month to your income for that period. You should be aiming for 8 percent a year. If you're not saving that much, you should look for ways to cut expenses and save more.
There are other ratios, too, but these are good ones with which to start. Don't get too hung up on these ratios. If your housing costs are 29 or 30 percent instead of 28 percent, it doesn't mean you should immediately sublet your apartment and move back home with Mom and Dad. But if you find your ratio is up to 35 or 40 percent, you ought to think about downsizing.