Anyone who has ever dealt with budgeting knows how difficult it is to keep up from month to month. But the other truth about budgets? They work.
If you want to control your spending and work towards your financial goals, you need a budget. A monthly budget is a plan to balance your income and expenses to meet long-term financial goals. When creating a personal budget, organize your monthly expenses into categories that will help you understand your spending habits – and move them around to meet your goals.
Having a personal budget that you review regularly is an essential part of financial literacy and the best way to avoid over-spending.
If you’ve ever found yourself in the difficult position of over-drafting your accounts or borrowing money, a budget can help you get out of the red and into the black. Instead of looking at a budget as negative, you can think of it as a tool for achieving your financial goals.
Why do you need a budget and what it does?
A written monthly budget is a financial planning tool that you can use to plan how much you will spend or save each month. It also enables you to keep track of your spending habits.
While creating a budget might not be the most exciting activity (and it is downright scary for some), it’s an important part of keeping your financial house in order. That’s because budgets rely on balance. If you spend less in one area, you can spend more in another, save that money on a large purchase, build a “rainy day” fund, increase your savings, or invest in wealth creation.
Ultimately, the outcome of your new budget will show you where your money is coming from, how much it has, and where it is going each month.
How to make a budget in 7 simple steps?
To create a budget that will work and give you a comfortable and happy life, you need to know exactly what you are currently spending, what you can afford, and what your priorities are.
Before you start creating a budget, find a good template that you can use to fill in the numbers for your expenses and income.
1. Gather your financial paperwork.
Before you begin, compile all of your financial statements, including:
- Bank statements
- Investment accounts
- Current utility bills
- W-2s and Paystubs
- Credit card bills
- Receipts from the last three months
- Mortgage or car loan statements
You want to have access to all information about your income and expenses. One of the keys to budgeting is taking a monthly average. The more information you can dig up, the better.
2. Determine your net monthly income.
The first step in budgeting is determining how much money you are making each month. If you have a job, this information can be found on your payslip – it’s the amount you take home with you per paycheck.
If you get paid on the 15th and 30th of each month, just multiply your paycheck amount by two. If you get paid biweekly, you should multiply your paycheck by 26 and then divide by 12.
If you have more than one job, irregular income, or are self-employed, the procedure for determining your net income (which is different from your gross income) is slightly different.
3. Track your monthly spending.
It’s helpful to track and categorize your expenses so you know where to make adjustments. That way, you can see what you are spending the most money on and where it is easiest to save.
Start by listing all of your fixed costs. These are regular monthly bills like rent or mortgage, utilities, or car payments. You are unlikely to be able to reduce these, but knowing how much of your monthly income they are taking can help.
Next, list all of your variable expenses – those that can change from month to month, like groceries, gas, and entertainment. This is one area where you may find opportunities to save. Credit cards and bank statements are a good place to start as they often list or categorize your monthly expenses.
4. Determine fixed and variable expenses.
Fixed expenses are the mandatory expenses that you pay the same amount for each time. Include items such as mortgage or rent payments, car payments, fixed fee internet service, garbage collection, and regular childcare.
When you pay a standard credit card payment, include that amount and any other major expense that stays the same from month to month. If you plan to save a fixed amount each month or pay off a certain amount of debt, include savings and debt payments as fixed expenses.
Variable expenses are the type that change from month to month, such as:
- Eating out
Assign an expense value to each category, starting with your fixed expenses. Then estimate how much you need to spend on variable expenses each month.
If you’re not sure how much you’re spending in each category, check your credit card or bank transactions over the past two or three months for a rough estimate.
5. Total your monthly income and expenses.
If your income exceeds your expenses, you are off to a good start. That extra cash means you can invest funds in areas of your budget, such as retirement planning or debt payments.
If your spending is higher than your income, it means you are spending too much and need to make some changes.
If you have more income than expenses, you should adopt the “50-30-20” budgeting philosophy. In a 50-30-20 budget, “needs” or essential expenses should make up half of your budget, needs should make up an additional 30%, and savings and debt payments should make up the last 20% of your budget.
6. Break your monthly expenses into categories.
Now that you have your lists of fixed and variable expenses, sort everything into categories. It can be helpful to use both general categories such as “food” and specific subcategories such as “Restaurants”, “Groceries”, and “Coffee” to learn more about your specific spending habits.
7. Make adjustment to expenses.
If you find yourself in a situation where the expenses are higher than the income, look for areas in your variable expenses that you can reduce. Find places where you can cut back on your expenses – like eating less – or eliminating a category – like canceling your gym membership.
The goal is for your income and expenditure columns to be the same. This even balance means that all of your earnings are booked and aligned towards a specific spending or savings goal.
How to use your budget?
Now that you have your budget in place, you need to monitor and keep track of your spending in each category, ideally every day of the month. The same budgeting table or app that was used to create your budget can also be used to keep track of your expenses and income totals.
Keeping a record of your monthly expenses will help you avoid overspending and identify unnecessary expenses or problematic spending patterns. Take a few minutes each day to record your expenses instead of putting them off until the end of the month.
As you use your budget, keep track of how much you’ve spent. Once you have reached your spending limit in one category, you will need to either stop that type of spending for the month or move money from another category to cover additional spending.
Your goal in using your budget should be to keep your expenses equal to or lower than your monthly income.