3 Components of a Spending Plan or Budget

Chapter Contents:

Learning Outcomes:

  • Learn the difference between negative cash flow and positive cash flow.
  • Create a budget for imaginary housing expenses.
  • Compare and contrast earned and unearned income.
  • Understand the differences between fixed and variable expenses.
  • Realize that spending decisions often reflect habits that develop over time.
  • Begin to understand how savings is an expense.

Personal Finance

Personal finance is the process of paying for or financing a life and a way of living. Just as a business must be financed—its buildings, equipment, use of labor and materials, and operating costs must be paid for—so must a person’s possessions and living expenses. Just as a business relies on its revenues from selling goods or services to finance its costs, so a person relies on income earned from selling labor or capital to finance costs. Personal finance addresses the “great difficulty” of getting a little money. It is about learning to manage income and wealth to satisfy desires in life or to create more income and more wealth. It is about a) creating productive assets: resources that can be used to create future economic benefit, such as increasing income, decreasing expenses, or storing wealth as an investment, and b) protecting existing and expected value in those assets. In other words, personal finance is about learning how to get what you want and protect what you have got.

There is no trick to managing personal finances. Making good financial decisions is a matter of understanding how the economy works, how money flows through it, and how people make financial decisions. The better your understanding, the better your ability to plan, take advantage of opportunities, and avoid disappointments.

  • Watch this video:

Creating a Monthly Household Budget

In this activity, students will:

  • Complete a budget for housing expenses.
  • Reflect on how budgets help people manage money.

Download activity:

  • A monthly household budget can help you make sure that you have enough money to pay for things you need such as rent, groceries, and electricity.
  • Paying for all your household needs before you spend money on things you want is a wise financial habit.

What Counts as Income

several banknotes of 5000 of different currencies

Distinguishing Between Earned and Unearned Income

In this activity, students will:
  • Explore the difference between earned and unearned income.
  • Play a game to practice distinguishing between the two types of income.


Download activity:  Distinguishing between earned and unearned income (guide)


The key takeaways in this activity are:

  • People can receive income even if they don’t work for pay. This type of income is known as unearned income.
  • Earned income is usually subject to federal and state income taxes, while unearned income may or may not be.

Tracking Income

In this activity, students will:

  • Learn key terms related to income and benefits.
  • Calculate weekly and monthly income and explore how income changes as a result of irregular monthly income.


Download activity:


The key takeaways in this activity are:

  • Income is the money you earn through hourly wages, salaries, tips, or commissions.
  • Income can be regular (a set schedule and amount) or irregular (inconsistent because the schedule or amount varies).

How to Count Expenses

Understanding and managing different types of expenses can help you control your cash flow and follow a budget.  There are two types of expenses: fixed and variable.

Fixed vs. Variable Expenses

When you make a budget, it helps to identify which monthly expenses are fixed and which ones vary.

Fixed expenses generally cost the same amount each month (e.g., rent, mortgage payments, car payments). Some fixed expenses (e.g., a utility bill) may also be variable because the amount changes each month depending on usage.

Variable expenses change from month to month (e.g., dining out, gas, medical expenses, groceries, or basically anything you buy from a store). If you’re trying to minimize spending to save money,

  • Watch the Video:

  • Answer these questions:
  1. Can I lower any of my fixed expenses so that I can save more money (for example, choose a cheaper Internet package)?
  2. Can I lower or eliminate any of my variable expenses so that I can save more money (for example, dine out less often)?

Differentiating Fixed and Variable Expenses

To manage your cash flow and maintain a budget, it’s helpful to understand different types of expenses.

Let’s try…

Making Spending Decisions

Common decision-making models can help you make informed spending choices.

In this activity, students will:

  • Understand the PACED decision-making model.
  • Apply the PACED model to making spending decisions.

People face a number of decisions about money every day. Understanding the differences between needs and wants helps you make a budget to manage your spending and informs your daily spending choices. Covering all your needs before you spend money on your wants is a wise financial habit.

The PACED decision-making model can help you learn the process of making thoughtful spending decisions by taking you through the steps of considering the problem, imagining alternatives to solve the problem, defining criteria for making a decision, evaluating the best choice for your situation, and settling on a final decision.


The PACED Decision-Making Model

Problem Identify the problem to be solved or decision to be made.
Alternatives Consider the options you have for solving the problem.
Criteria Decide what features or qualities you’ll use to compare the different options.
Evaluate Analyze the options based on your criteria.
Decide Make a decision based on the results of your evaluation.


Activity: Building Blocks Student Worksheet: Making spending decisions


The key takeaways in this activity are:

  • Know that your fixed expenses are the same from month to month.
  • Know that your variable expenses will be different from month to month.
  • Make sure that you account for the variable expenses in your budget.
  • Use the PACED decision-making process for your spending decisions.

Shared Expenses

When you have roommates, the essential expenses, such as rent, utilities, and food, should be divided equally. However, rent and other expenses may sometimes be shared based on the size of the room, utilities usage, and food consumed.

Example: There are 3 roommates. If the rent and utilities are $1500 per month, then each roommate is responsible for contributing one third (1/3) of the essential expenses or $500.

In most cases, one person will have leased or rented the apartment or house and is responsible for paying the rental agency or owner.  The lead roommate (person who signs the lease) will let the other roommates know when the essential expenses are due.  Each roommate should agree to have their share of the essential expenses available prior to the due date of the essential expense.

Unfortunately, some roommates may not be able to meet their share of the expenses due to an unforeseen occurrence. It is advisable for the lead roommate to have money put aside in their budget to make up the difference.  This set-aside money should NOT be included in the shared expenses.

The most important thing to note is that each roommate should take full responsibility for their share of the essential expenses.  In some cases, the lead roommate has obtained a sublease agreement that the other roommates sign to ensure that they pay their portion of the essential expenses.

Strategies for Saving

Saving on a regular basis can help you make progress toward achieving your goals and better handle unexpected expenses when they come up. It is money you set aside today to use in the future. It could be for something you need in the next few months or even years from now.


People save for many reasons:

  • Unexpected expenses and emergencies.
  • A bill they know will be due every few months, such as car insurance.
  • Annual expenses like children’s school supplies.
  • Their own goals, such as a new TV, appliances, a car, a home, their children’s education, or retirement.


There are common categories that most people think about when setting their savings goals:

  • Saving for emergencies
  • Saving for periodic expenses and goals
  • Saving for lean times
  • Saving for education

Saving for Emergencies

Everyone has unexpected expenses and emergencies—a car repair, the need to travel to help a sick family member, paying the bills when you’ve had a cutback in hours or even lost your job. When you save in advance for unexpected expenses and emergencies, you are better prepared to handle them without having to skip paying your other bills or to borrow money. Saving money now for unexpected expenses and emergencies can save you money later.

Consider starting an emergency fund with $500 as your goal (McCallister-Young, 2021). This sum is enough to cover a lot of common emergencies such as a new tire for your car, a plane ticket to care for a sick family member, or minor medical costs. Once you reach $500, consider increasing your goal to $1,000. This may be enough to help cover your rent if you lose your job, take care of an insurance deductible for major car repairs, or pay for many household repairs. Having this kind of emergency savings fund is the foundation for setting other savings goals. Once you have this set up, it’s easier to focus on saving for other things without worrying about how you would handle an emergency expense.

While the target amount for an emergency fund will vary from person to person based on their needs, $500 to $1,000 has been suggested as a starting point.

Saving for Periodic Expenses and Goals

Once you have some money set aside for unexpected expenses, you can start planning for upcoming expenses and goals. Many people have goals they want to accomplish that require saving money. Some goals can take several months to achieve, such as saving for a new TV. Others can take many years, like paying for a child’s education. If you decide to save money for such a goal, make sure the money you’re saving is separate from your emergency fund. That way, if an unexpected expense comes up, using your emergency fund won’t come at the cost of achieving your goal. It’s also important to save for periodic expenses (those that come only once or a few times a year) like renters’ insurance, income taxes, car insurance, or children’s school supplies. While they’re not unexpected, these expenses can be difficult to pay for all at once if you haven’t been setting money aside for them.

Saving for Lean Times

Saving money is particularly important if your income fluctuates or varies from week to week. This variation could exist because your income changes depending on how many hours you are scheduled to work each week. It could also be because you work seasonally, rather than year-round. In both situations, setting aside money in weeks or months with higher income can help you pay your bills on time when your income decreases or stops.

Watch the Video:

Saving for an Education

Saving for college or technical training for you or your children may be one of your goals. Training and education after high school can be an important investment of both time and money. Saving for education can reduce the amount of student loans you need and may provide more options for education and training after high school. There are many financial products that can help you save for an education, including savings accounts and certificates of deposit. There are also investment products designed specifically for this purpose. One option is a 529 savings plan. These tax-advantaged savings plans can help parents, guardians, grandparents, and others save and invest for an education. For more information on saving for education expenses using a 529 plan, visit collegesavings.org.

You can also save while receiving public benefits. If you receive public benefits and want to start saving for emergencies and goals, you may want to know about asset limits. Assets are things that you own. Assets can include money in a savings or checking account, and things like your car, home, land, and business inventory. Asset limits are rules about how much you can have or save before your benefits are reduced or taken away. Since assets help people achieve financial security, some assets won’t count against allowable limits. Generally, the assets that may count against allowable limits are “liquid,” which means they are similar to cash. Some examples of liquid assets are money in a checking account, savings account, or investment accounts. While things like a home or car that you own are also considered assets, they’re not liquid assets, so some program rules don’t count them against the allowable limit. Different benefits have different limits and all states have their own asset limit policies. Knowing each program’s asset limits may help you avoid unexpectedly losing your benefits as you’re saving to reach your goals. Use the “Saving and asset limits” tool (linked below) to figure out the asset limits for your benefits.

Saving is hard on a tight budget. After you’ve made a decision to save, you have to find the money to do it. There are only two ways to find money to save: spend less or earn more. You can decrease spending and put the money “not spent” into savings.

You can also increase your income as a way to increase savings. You could work a second job part-time and save some of that extra income. Sometimes you experience an unexpected increase in income. Consider setting aside some of this “extra” income into your savings account.  If you get paid bi-weekly, there are two months each year when you get three paychecks instead of two. You can take advantage of this “extra” paycheck to save for unexpected expenses later in the year



If you receive a tax refund, you could save part of it for emergencies or unexpected expenses, set it aside for predictable annual expenses, or put it toward meeting one of your goals.

  • Watch the Video:

Making Savings Automatic

People who save successfully generally choose an automatic system of saving for their goals. They make the decision about where to save, set up the system, and then save money from every paycheck without having to think about it. If you have a bank account and direct deposit, you can arrange to automatically deposit some of your paycheck into a savings account every time you are paid.

  • Watch the video:

Key Takeaways:

  • It is important to understand the sources (incomes) and uses (expenses) of funds, and the budget deficit or budget surplus that may result.
  • A monthly household budget can help you make sure you have enough money to pay for things you need like rent, groceries, and electricity.
  • Earned income is usually subject to federal and state income taxes, while unearned income may or may not be.
  • Income can be regular (a set schedule and amount) or irregular (inconsistent, because the schedule or amount varies).
  • Your fixed expenses are the same from month to month.
  • Your variable expenses will be different from month to month.
  • Savings should include money for emergencies.

Please Provide Feedback

What is one tip that you learned from this chapter?


McCallister-Young, K. (2021, January 31). 38 reasons you need at least a $500 emergency fund. America Saves. https://americasaves.org/resource-center/insights/38-reasons-you-need-at-least-a-500-emergency-fund/

Siegel, R., & Yacht, C. (2009). Personal finance. Open Textbook Library. https://open.umn.edu/opentextbooks/textbooks/31