A Step by Step Guide to Creating a Budget
Do you live from paycheck to paycheck? Do you sometimes run out of money even before the month ends and you are left wondering where all your money went? If you answered yes, that's okay - you, like millions of other people, are going through a tough financial situation. However, while achieving financial independence can be difficult, it is not impossible. With that said, if you want to gain more control over your finances, you are going to need a budget.
Now, the concept of creating a budget can be overwhelming and perhaps even scary as a lot of people tend to associate budgeting with restrictions in spending. However, the essence of budgeting is to allow for more efficient spending, not restrict it. A budget can help you evaluate how much money you make against how much you spend and what exactly you are spending on. So, rather than regarding a budget as a negative tool, it should be viewed as an essential tool that can help you work towards attaining your financial goals.
Whether that goal is to pay off your high-interest debt, save for retirement, make a major purchase, pay for the children's college tuition or even go on a dream vacation, creating a solid budget is the first step towards realizing your financial goals. But how do you create a budget? What do you need to do? If you are unsure of how to go about budgeting, do not worry. This step by step guide will walk you through the process of creating a solid budget that can help you control your spending and build wealth.
- Decide to create a budget
If you are reading this, then it is safe to assume that you have ready-made the decision to create a budget for yourself. However, there is a lot more to starting a budget than just deciding to. You have to be ready to organize all your financial statements because you are going to need then. From your bank statements to your utility bills, every record that has to do with money earned or spent is relevant.
It is imperative to understand that to create a sound budget that will be effective, you must ensure that the information you provide is as accurate and detailed as possible. As long as you omit or conceal financial records, then it is unlikely that your budgeting plan will be successful. This first step is one of the most difficult steps in the budget-creating process and once you are set on the decision, then you are ready to create a budget.
- Determine your net income
What is your final take-home pay? How much do you make in a month after tax deductions? This is your monthly net income and it is of utmost importance that you know how much money you are bringing in when creating a budget. Now, if you do not earn a regular income, like people who are paid hourly, work part-time, freelance, or work in a business where income is unpredictable, it can be slightly more difficult to calculate your monthly net income compared to those on the standard salaried pay scale.
In this scenario, you can calculate your monthly net income by finding an average of 6 to 12 months of your income. Use the figure you get as your net income. If you have other sources of income that you use to supplement the income from your regular or full-time job, like a hobby or talent that pays you money, be sure to record it as part of your income as well. Essentially, the total amount of money you make every month is your income. Record this figure and understand that it can be quite simple to overestimate what you can afford to buy when you think of your whole income as available for spending.
- Determine your expenses
Having established all your possible sources of income with an idea of how much money you have coming in every month, the next step in the budget creating a plan is to decide where the money you make goes to. In other words, calculate your average monthly expenses. Start by listing your fixed and variable expenses. Fixed expenses are bills like insurance payments, mortgage and electricity bills. These bills are fixed because they are unlikely to change and you can not just cut back on them.
Next, calculate your variable expenses, this covers money spent on gas, groceries, and entertainment. These other bills vary on a monthly basis and you can cut back on some of them if you want to. Consult your financial files, bank statements, and receipts. Track and record every cent you spend and you should be able to account for any money that leaves your bank account. Now because some expenses may be intermittent, it can be difficult to get an accurate figure for your monthly expenses. Thus, finding an average of 6 to 12 months of your expenses can give you an insight into how much you spend monthly.
When calculating your expenses, it is also important to take into consideration unplanned expenses like medical bills and automotive repairs. Ensure that you are as thorough as possible when calculating your expenses. One forgotten bill is capable of wrecking your budget. If you can meticulously track your expenses, you might be amazed by your spending habits.
- Set your financial goals
Now, before you begin to sift through the financial data you have collected and tracked, first off, you should consider your financial goals. In essence, why are you budgeting? What financial goals do you want to achieve, both on a short term and long term basis? Your short term goals are plans that ought to be achievable within one year. For instance, your short term goal could be budgeting to save up for a luxury vacation, buy a new car or clear your credit card debts.
Your long term financial goals, on the other hand, may include plans like saving for your child's college tuition, saving for retirement, etc. These goals often require more money and may take years to attain. Setting your financial goals before you create a budget will help you identify your priorities to give you a clear picture of what you are saving up for, how much you may need to save up and when you intend to have the money ready.
Now, it is pertinent to understand that your goals do not have to be set in stone. You should be able to change them at any time depending on how your priorities change. For example, you can decide to postpone your vacation till another year if a more important need arises for the money. Remember, the essence of budgeting is not to restrict how you spend your money, it is to ensure that every dollar you spend, is well spent and accounted for.
- Create your budget
Now, once you have an idea of how much you are making and what you are spending, you can then proceed to create your budget. First of all, start by putting down the information you have gathered thus far. There are a variety of software programs like Microsoft Excel and online budgeting tools such as Personal Capital, Mint and Pocket Guard that provide budget templates and spreadsheets you can use to create and track your budget. You can always stick to the traditional paper ledger if you are not tech-savvy enough for the online budgeting tools. The most important thing is to have a database for your financial information, somewhere you will be able to track your finances effectively.
Once you've correctly entered the information, total your income and your expenses. This calculation will help you determine if you are living within your means if you are spending too much or not. If your income is higher than your expenses, then that's a good start. On the other hand, if your expenses exceed how much money you earn, then you will need to make some changes. This calculation is what will help you prioritize your money and make adjustments as necessary.
- Decide on your budget plan
There are several budgeting methods, however, the most popular and widely used method of all is the 50/30/20 budgeting plan. This method simply breaks down your income into three categories: 50% for needs, 30% for wants and 20% for savings. The 50/30/20 method is quite easy because it allows flexibility in your budget.
For instance, what you consider as wants can differ from month to month but provided the spending does not exceed the 30% allocated to it, then you are still on track. Also, the rule is indifferent to how much goes for your utilities or rent, as long as it stays within the limits set by the category it belongs to, you’ll continue progressing towards your goals. Most online tools use 50/30/20.
Another popular budgeting plan is the zero-based budget. This method is based on the idea that any money that is not tracked will be misused. Thus, every single dollar should be assigned to an expense such that your total income minus your total expenses will equal zero hence the name zero-based budget.
To illustrate, if you earn $5,000 every month, every single dollar of the $5,000 must be assigned a value, be it savings, fixed expenses or variable expenses. This method demands accountability as you will be forced to analyze every expense. In all, whatever budgeting plan you go for, ensure that it covers the three important categories, your needs, some wants, and savings.
- Track your budget
As important as creating a budget is, it will not have any impact on your financial life unless you are tracking it. This is why it is important to review your budget on a regular basis. When starting out, weekly budget reviews are recommended. However, as you grow into it, you can reduce the frequency to at least once a month. No matter how established your budget is or how much of a thoughtful spender you might consider yourself to be, always make out time to review your budget. This reviews can help you make corrections before your expenses begin to go off course. Because, once you lose track of your spending, you begin to steer yourself away from your financial goals.
- Make adjustments to the budget accordingly
Nothing about your budget should be set in stone. Your priorities, income, and expenses are likely to change with time. As they do, so should your budget. Also, it is highly unlikely that your first budget will be your last. Be prepared to go through a number of budget plans before you find one that suits you. Constantly tracking and monitoring your income and expenses will help you identify your weak points and evaluate your spending habits to adjust your budget accordingly. For example, you might consider cutting back on some seemingly insignificant expenses like going out to see a movie and eating out. These minor expenses can add up to a pretty significant amount of money which could have been channeled towards your goals. You might be amazed by the extra money that could stack up when you make minor adjustments to your budget.
It is never too late to make a budget and if you do not have one, there is no better time to create one than now. The 8 aforementioned steps can help you create a solid budget that will put you in control of your finances and allow you to save towards your goals. Remember to keep things realistic when creating your budget. Re-evaluate as required, but no matter what happens, resist the urge to give up. A sound budget might be the difference between living paycheck to paycheck and financial freedom.