Budgeting is the most basic and the most effective tool for managing your money. Yet, most people avoid doing it because it is additional work and connotes that you have to give up and stop yourself from enjoying stuff. This could be further from the truth though.
What budgeting actually does is clearly show you how you allocate your money and present you the choices on what stuff to enjoy – based on your financial limitations. It will save you the grief of overspending and being too much in debt. Budgeting does not stop you from enjoying stuff, it ensures that you enjoy stuff when you want it.
By now, you’re probably sick of hearing the “b” word. Too bad. This is just one of those financial lessons that cannot be preached enough. If you want to achieve financial freedom, following a budget is the only answer. In the following below I am going to go into detail on why you need to create a budget and how to create a simple one for yourself. Remember the important thing is that you STICK to your budget.
Why is having a budget so important?
Gives you control over your money
A budget is a way of being intentional about the way you spend and save your money. It is said that with budgeting, you control your money and not your money controls you. Budgeting saves you the stress of suddenly having to adjust to lack of funds because you did not initially plan how to spend them. It also helps you decide if you want to sacrifice short term spending like buying coffee everyday in exchange for a long term such as paying off your debt or investing.
Keeps you focused on your money goals
You avoid spending unnecessarily on items and services that do not contribute to attaining your financial goals. If you are working with limited resources, budgeting makes it easier to make ends meet. This will help you separate your wants and needs.
Makes you aware what is going on with your money
With budgeting, you are clear on what money is coming in, how fast it goes out, and where it is going to. Budgeting saves you from wondering at the end of every month where your money went. A budget enables you to know what you can afford, take advantage of buying and investing opportunities, and plan how to lower your debt. It also tells you what is important to you based on how you allocate your funds, how your money is working for you, and how far you are towards reaching your financial goals.
Helps you organize your spending and savings
By dividing your money into categories of expenditures and savings, a budget makes you aware which category of expenditure takes which portion of your money. That way, it is easy for you to make adjustments. Budget also serves as a reference for organizing your bills, receipts, and financial statements. When all of your financial transactions are organized for tax time or creditor questions, you save time and effort.
The stress of having your finances out of whack can take its toll on your body and mind. Managing your personal finances can be as important to your physical and mental health as working out at the gym. Stress has a way of affecting every part of your life. Take control of your finances from this point forward and work out problems as quickly as they arise. However, don’t become so obsessed with finances and money to the point where you can’t enjoy yourself.
Now that I have covered off the five main important reasons for having a budget lets get into how we create one.
How To Create A Budget
First and foremost before getting into the process of creating a budget you need to calculate your yearly discretionary income. Once you have done this you will know exactly how much money you have to work with each month. So please do that before you get into this exercise. Once you have that number write it down because this is what we are going to work off of.
Step 1: Gather every financial statement you can
This includes bank statements, investment accounts, recent utility bills, cell phone bills, car payments, insurance payments, student loan bills and any information regarding a source of income or expense. One of the keys in the budget-making process is to create a monthly average, so the more information you can dig up the better.
Step 2: Create a list of monthly expenses
Write down a list of all the expected expenses you plan on incurring over the course of a month. This includes a mortgage payment, rent payments, car payments, auto insurance, groceries, gym membership, cell phone bill, utilities, entertainment (Netflix subscription), dry cleaning, student loans, retirement or college savings — essentially everything you spend money on.
Step 3: Break expenses into two categories: fixed and variable
Fixed expenses are those that stay relatively the same each month and are required parts of your way of living. They included expenses such as your mortgage or rent, car payments, cable and/or internet service, trash pickup, credit card payments and so on. These expenses, for the most part, are essential yet not likely to change in the budget (We will work on lowering them just keep reading through the blog). Variable expenses are the type that will change from month to month and include items such as groceries, gasoline, entertainment, eating out and other things you spend your money on. This category will be important when making adjustments.
Step 4: Total your monthly income and monthly expenses
Now that you have calculated your yearly discretionary income divide that by 12 to get your monthly discretionary income. Take this number and subtract the total monthly expenses. If your end result shows more income than expenses, you are off to a good start. This means you can prioritize this excess to areas of your budget such as paying off debt or investing. If you are showing a higher expense column than income, it means some changes will have to be made.
Step 5: Make adjustments to expenses
If you have accurately identified and listed all of your expenses, the ultimate goal would be to have your income and expense columns to be equal. This means all of your income is accounted for and budgeted for a specific expenses and savings goals. If you are in a situation where expenses are higher than income, you should look at your variable expenses first to find areas to cut. Since these expenses are typically non-essential, it should be easy to shave a few dollars in a few areas to bring you closer to your income. The best way to figure out where you can cut from your expenses is to track your spending and record every expense for a month. Seemingly insignificant items such as a cup of coffee add up over time. For instance, even if you spend just $5 a week on snacks, that adds up to $260 a year, which is not insignificant.
Step 6: Set Savings and Debt Payoff Goals
If you determine you’re making more money than you’re spending, congratulations. This amount can be earmarked for paying off debt and investing. Once you have a clear picture of where all of your money goes, be merciless in cutting expenses until your budget is in the black. Cut enough so that you have 10 percent to 20 percent of your income left over each month to pay off more debt or use towards investing. If you are unable to cut a sufficient amount from your budget, consider ways you can increase your income.
Step 8: Enter this Information into a Database
It used to be, if you had a budget, you had an old school paper ledger. Things have changed for the better for all of us new budgeters. Software programs like Microsoft Excel and online budgeting tools like Mint, You Need a Budget, and Mvelopes have made it much easier to take the results of your first few steps, and develop a highly adjustable and sustainable long term budget. I use Microsoft Excel for my own personal budget, because it allows a greater deal of flexibility than sites like Mint. However, many people swear by online budgeting sites, and whichever path you choose will ultimately help you build greater wealth and greatly help keep you out of financial trouble.
Step 9: Review your budget monthly
It is important to review your budget on a regular basis to make sure you are staying on track. After the first month take a minute to sit down and compare the actual expenses versus what you had created in the budget. This will show you where you did well and where you may need to improve.
If you don’t have a budget, now’s the time to create one. By following the steps above, you’ll be on your way to financial freedom and building wealth for the future.