What is the Primary Purpose of a Cash Budget?

A cash budget makes budgeting more effective.

A cash budget is a budget in which you use cash to pay all your bills. It doesn't mean you need to pay for everything with actual cash, but rather, you only budget money that you actually have and you don't use credit to cover your expenses. Generally, when speaking of a cash budget, most people mean business budgeting, but it's a concept that can be applied to personal budgeting, as well. The primary purpose of a cash budget is to stop using credit by only using the money you currently earn to cover your expenses. It helps to prevent debt and build wealth.

Benefits of a Cash Budget

Cash budgeting requires you to work with the money you actually have on hand. This prevents you from overspending and accumulating debt. When using a cash budget, you should look at each month's income before deciding how you're going to cover the bills for that month. It's important to budget for irregular expenses, or times when your power or heating bills are higher than average, as well.

Disadvantages of a Cash Budget

Without careful planning, a cash budget may run short some months if you have unexpected expenses. This can lead to cash flow problems. Setting aside money each month for an emergency fund can prevent this problem, as can saving up for most expenses beforehand -- including large ones, such as the purchase of a car.

Using a Cash Budget

The total amount of your expenses should be equal to, or less than, your monthly income. To set up a cash budget, you need to estimate the amount you spend monthly on necessary budget categories, such as food, rent and utilities. These cannot be changed, but if you need to trim expenses to stay within your income, budget less money for other areas, such as clothing or entertainment. Once you've set your limits, record the amount you spent in each category, so you'll know when to stop spending.

Choosing to Pay with Cash

Although it isn't practical to pay most of your bills with cash, switching to cash for your problem categories can be helpful. This method allows you to physically see how much you're spending. Create an envelope for each problem category and put the budgeted amount of cash in the envelope. Save your receipts and put them in the envelope to track where and how you spent the money. When you run out of cash, you know to stop spending. This method works well if you don't have time to update your budget each month.

References

• CNN Money; Making Your Budget
• MSN Money; Build Your Own Budget