Budgeting, simply put, is a spending plan. It helps us to live within our means and get out of debt. It can also help us save for the future. However, before we can accurately set up a household budget, we need to have a good understanding of what we’re spending our money on.
Here are the stepping stones on how to create a budget:
1. Keep Track of Every Penny Spent for the Next 30 Days
Buy an inexpensive small notebook and list every expenditure you make however small it may be. If you put a quarter into a parking meter, write that down, too. This is the best way – writing it down right after you spend.
If this is too tedious for you, the next best thing is to recount the expenses you made throughout that day at the end of the day. This will require a good memory and not more than 15 minutes each day. Because I tend to forget small purchases, I simply tote around a notebook and a pen and jot down the expense as it occurs.
At the end of the month, write down all your expenses in categories on a spreadsheet or piece of paper. Use general categories like dining out, food, entertainment, parking fees, etc. I use an Excel spreadsheet, but if you do not have this software, you can use a free Google spreadsheet.
(Note: Other alternatives to pen and paper for tracking your money are free management software or inexpensive paid budget software like “Your Need A Budget“. I have been using this software for two years now, and I am very pleased with it. That is an unsolicited endorsement. I do not get any payment from the company.)
Once you have your list, share this list with your spouse, if you are married, and decide which of these listed expenses can be eliminated or at least reduced before going to Step 3.
2. Keep Track of All Your Income for the Same Time Period
Income can be derived from salary, bonus, hourly, self-employed, passive or investment sources. In some cases, you can control your income, i.e. working longer hours or a second job, taking on additional clients, or choosing investments that provide higher levels of income. In most cases, control is limited.
This is a simple step if your income does not vary, whether you are a family with dual income or if you have multiple streams of incomes. All you need to do is to add the annual amount and divide by 12 to get the monthly amount.
If you have a variable income, you will need to determine the average of your variable annual income, then divide by 12. Use this as your monthly income. Do not over-inflate your average variable income. It is better to err on the safe side than to use the inflated amount giving you false security that you can spend more with this bigger amount.
3. Make A List of All Monthly Expenditure
We have two different types of expenses – fixed expenses and variable or discretionary expenses.
Fixed expenses are those that we pay a set amount every month and are usually long term. Examples of these include mortgage or rent, car loans, student loans, taxes and life, medical or dental insurances (if these were not taken out before you receive your income). Remember that fixed expense is a debt that you agreed to pay your debtor X amount every month for Y number of years. You have limited control over fixed expenses.
For fixed expenses that you pay quarterly, semi-annually or once a year, calculate how much is the expense for a full year and divide it by 12. This will be your monthly expense per year that you need to track and included with the other fixed monthly expenses.
Notice that food, though a necessity, is not a fixed expense. It is a variable expense. Some finance people call this “Discretionary Expense.“ The amount you spend fluctuates from month to month where you can make a choice of spending less or more. Thus, you have more control over variable expenses. Examples of variable expenses: food, utilities, entertainment or recreation, clothing allowance, gifts, and others.
4. Compare your Income and Expenses
Compare your total monthly income with your total fixed expenses. If your income is less than your fixed expenses, you have a problem. You will need to either increase your income or decrease your expenses or do both.
If your income is more than your fixed expenses, compare the excess income with your variable (discretionary) expenses. If you do not have enough income to cover the variable expenses, you will also need to decrease your expenses or increase your income until it all works out.
5. Set Up an Emergency Fund
An emergency fund is your “safety net” from unexpected financial misfortunes such as losing your job or source of income or a big hospital expense due to an accident or an unforeseen health problem. The amount you need to save should be at least equal to 3 months of your expenses.
Gradually build your emergency fund by depositing the same amount each month and add this as part of your fixed expenses. If your income is just enough to cover your fixed and variable expenses, you can use a “windfall” (receipt of unexpected money, examples: tax refunds, cash bonuses or gifts) to build up your emergency fund.
Does this sound overwhelming? It could be, but with a little practice, patience and time you will feel comfortable with tracking where your money goes and how to control its outflows.