If that’s how you manage money, things won’t go well. Before long, your expenses easily outstrip your earnings leading to a financial meltdown.
First let’s dump the misconceptions about budgeting. It isn’t about self-denial, though a solid plan usually contains an element of that. Rather, it’s about outlining your near-term financial future. Remember writing term papers in school and the teacher telling you to make an outline before you began writing?
A budget is like that – a plan for where your money will go before you earn it.
Budgets won’t protect you from disasters, but they can help you avoid them. Unexpected car troubles or a big medical bill can disrupt even great plans, but a good budget can mute the impact. Part of your budget will allocate savings to help you build an emergency fund.
When you get ready to budget, remember to be honest. Self-deception is the worst thing you can bring to the process. Budgets only include money you realistically expect to receive. They don’t include unforeseen windfalls like chance inheritances or winning the lotto.
Budgets have various purposes. They can help you save for a specific goal, like buying a car or a house. They also can help you pay down debt or build a nest egg. When you start the process, decide what the objective is and write it down. It’s easier to reach your goal when you’re reminded of it every month.
To start, resolve to live within you means. Consider Rachel, 26, who is single and takes home $3,500 a month. Her rent is $1,200 a month and she spends $300 a month for groceries. She enjoys eating out, flying to visit her parents several times a year, going to clubs and concerts and maintaining social media accounts. Expenses also include a car, a puppy and a gym membership. And, oh, $300 a month student loan payments.
Rachel outflows average $3,600 a month. The $100 monthly shortfall now goes on her credit card, and the growing interest payments on her credit card is eating up more income every month.
What should she do?
Step one is taking a sheet of paper and drawing a line down the middle. Income is on the left; expenses on the right. She needs to devise a plan that balances the two and, hopefully, leaves a couple hundred dollars untouched for an emergency fund. It’s not easy, but it can be done. Here’s how:
How To Calculate Monthly Income
When it comes to a budget, take-home income is the only income that matters. Forget about pre-tax earnings. Your take-home pay is what you can spend or save. Here’s how to determine what your monthly take-home income is:
If You Are Paid Bi-Weekly
If you are paid a consistent salary ever other week, multiply your take-home pay for one paycheck by the number of paychecks in a year: 26. Then divide this number by 12 to get your monthly income.
If You Are Paid Weekly
Take your weekly pay and multiply it by the number of weeks in a year: 52. Divide this number by 12 to get your monthly income.
If Your Pay Fluctuates
If your pay fluctuates based off of tips, varying hours and/or commissions, you can still calculate an estimated monthly income by adding up 3 months worth of income and then dividing by 3.
When calculating income, also include other income like social security, disability, pension, child support, and alimony. Any money that you regularly receive can be considered income for your monthly budget.
Your Monthly Expenses
It can be difficult to remember all of your monthly expenses. Start by listing out the bills you pay each month. These will likely include:
After you’ve listed your monthly bills, add in variable expenses including:
- Food: groceries and eating out
- Pet expenses
The strength of a budget will be determined by how accurate it is. Look at 3 months worth of credit card and/or debit card charges to make sure you are capturing all of the categories where you typically spend money.
Compare Income and Expenses
Once you’ve identified all of your expenses, add them up. How do your expenses compare to your income? Do you have a surplus or a deficit?
If you have a surplus, consider how you’ll invest or save the surplus money.
If it’s a deficit, study the expenses and decide what to cut. If one of the biggest outflows is lunch at work, consider brown-bagging it four days a week. If it’s a cable TV bill, go for a cheaper plan or cut the cord. A big cellphone bill? Find a cheaper plan or a less expensive provider.
Managing expenses might not be enough. If you can’t get where you need to be, turn to the income. Can you work overtime or find a second job a few nights a week? It might be necessary.
Your income should always exceed your expenses. Budgeted expenditures should never exceed 90 percent of your income. Remember, this is a goal and you might not make it every month, but that’s why you keep a savings account as a backup. Only tap that emergency fund when absolutely necessary, and deposit extra money to it during any month when you take in more than you budgeted.
Using a budget calculator can help you quickly add up your income and expenses. InCharge’s online budget calculator will help you capture all of your expenses and assess what income is required to maintain your expenses.
Ways To Budget
You can keep budgets on paper, but there are also lots of apps and software that can help you plan your cash flow more efficiently. Quicken, Mint, You Need a Budget and GoodBudget are some the best known and longest running programs. Banks, mutual funds and investment-advice companies offer their own budgeting apps. Look around and find one that works for you.
Remember that a key part of the process is tracking actual cash flows. Keep a ledger or enter income and expenses in a computer program. Then compare the results to the budget. If you’re expenses are too high, rein them in.
Whether a paper budget or something on a computer or smartphone, remember that the budget is a planning tool. You have to take the actions needed to make it work.
Here are some of the top budgeting software options:
Mint, from accounting software powerhouse Intuit, allows you to connect your bank accounts and credit cards and track your expenses. It categorizes them as well and can compare them against budgets you set up. Mint will also send email alerts when you pay bank fees or exceed budget categories. Mint’s expense tracking and budgeting software is free, though you will be targeted with advertising based on your consumer profile.
You Need A Budget is a paid budgeting app that also connects with your bank accounts and credit cards, tracks your spending and allows you to set up budgets and savings goals. The cost is $5 a month or $50 per year. There is a smart phone app that can help you check your spending against your budget in real time.
- Don’t confuse luxuries with necessities. Eating is a necessity. Eating at a four-star restaurant is a luxury. If you have to trim expenses, pare back on the luxuries.
- Watch the small stuff. If you like passing time in coffee shops, add up what you spend each month. The sum of all those $4 lattes might shock you. So drink water sometimes, or work at home and make your own coffee.
- Restrain yourself. Just because you earn a raise doesn’t mean you have to find new ways to spend money. Consider saving part of it or contributing more to a workplace 401(k) retirement plan.
- Use cash. Credit and debit cards are great conveniences, but also easy to overuse. When you spend cash, or write checks and enter them in a register, you’ll more accurately see what your dong with your money. Finally, using cash isn’t an excuse to visit an ATM when you get the urge to spend. Use your budget to set limits on yourself and keep receipts to monitor your progress.
- Manage your own debt. If you have a growing unpaid balance on your credit cards, part of your budget should aim at bringing the balance to zero. Paying revolving credit card debt is one of the least useful ways to spend your money.
- If your debt is out of control, consider debt consolidation programs that lower your interest rate and your monthly payment.
A spreadsheet is a good tool to use while budgeting because you can change your assumptions and see how they affect your surplus and/or deficit. A well-designed budget spreadsheet will have formulas pre-programmed to add up your expenses and subtract them from your income. You can see how reducing costs 5-10 percent across small areas of your budget add up to larger savings.
When maintaining a budget spreadsheet, consider having two: one spreadsheet reflecting your actual income and expenses and a duplicate that reflects your goals: expenses you are working on reducing (monthly debt payments, for example) and income opportunities you are working to grow. Your goal budget can help you visualize the power of savings over time. Remember, any expense you are able to reduce permanently represents recurrent savings: savings times twelve months in the year.
Download InCharge’s Budget Spreadsheet
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Check out our video on how to budget, hosted by InCharge’s Sergeant Debt.
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Schwartz, S. (ND) Secrets to Creating a Budget. Retrieved from: http://www.bankrate.com/finance/financial-literacy/secrets-to-creating-a-budget-1.aspx
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Set your goal.Defining a goal makes it easier to stick to your budget, and gives you a way of measuring your success or failure in meeting it. Why are you going on a budget? Maybe you want to start saving for college, or maybe you want to get out of debt. Whatever the case, make sure you set a SMARTER goal (a goal that is Specific, Measurable, Achievable, Relevant, Time-bound, Evaluated, and Reviewed regularly) to improve your chances at success from the beginning.
Calculate how much money you earn after taxes in a typical month. Begin by figuring out exactly what you bring home each month--your net income after taxes and other deductions, which includes your paycheck, tips, scholarships, legal entitlements like child support, alimony, government subsidies, and any other money that comes into your wallet or bank account. This is your income.
- Fixed Expenses are expenses that remain relatively stable from one month to the next. These will include items such as your rent, mortgage payment, car payment, loan payments, utilities, and insurance. A fixed expense that many people overlook is savings. You must pay yourself--in the form of your savings account--before you pay anyone else. This way you can develop a financial "padding" to protect yourself during times of financial hardship.
- Variable Expenses are items that fluctuate from one month to the next such as the costs associated with dining out, entertainment, clothing, groceries, personal care products, and vacations. This will be the first place to make cut-backs if you are spending beyond your means.
Divide your budget into basic categories. For example: "Housing," "Food," "Auto," "Entertainment," "Savings," "Clothing," "Medical," and "Miscellaneous." You could also organize your expenses into needs - such as your loan and electricity - and wants - such as clothing and entertainment.
List all your spending for each category. Let's take "Auto" as an example, and say that each month you have a car payment of $300 and a $100 insurance bill. In addition, every month you spend an average of $250 on fuel, $50 on maintenance, and $10 on taxes and fees, such as registration. So, in the "Auto" category, your total budget for the month would need to be at least $710 per month. If, for some reason, you don't know the exact amounts you spend in a category, make good estimates. The more accurate you are, the more likely you are to keep to your budget plan.
Add up all your spending by categories. This should show your total monthly spending, or how much money you take out of your wallet or bank account each month. Compare it to your income.
Decide on a method to keep track of your budget. You can use a good old-fashioned ledger book, available from a general shopping center for about $5. However, many people prefer to use computer programs like Quicken, Microsoft Money, or Excel.
Set up your ledger. If you chose to get the ledger book, leave the first five odd pages blank, we'll come back to them later. Divide the rest of the ledger into as many sections as you have main categories. Put each main category on the first page of each section. This will give you room for lots of entries in each category. Multiple transaction categories, like "Food," are going to need lots of pages.
Show a "deposit" in each category at the start of each period, then show all the expenditures from that category throughout the period. So, for "Auto" you would start off with $710 for the month, then show several expenditures for "fuel", one expenditure for "car payment", and maybe one expenditure for "insurance" (depending on whether you pay for insurance monthly).
Use that first section of the ledger book which we saved earlier to record income and show the budget being subtracted from it each period. For instance, If you get paid every other Friday, there should be corresponding entries in the income section showing income deposits at the same interval (every other Friday). Thus, if your monthly budget is $2,800 and gets subtracted on the 1st and 15th of the month, on each 1st and 15th the income sections should show a total deposit of $1,400 and, for the same period, your "Auto" section should show a deposit of $355 from which you can subtract as you spend from your budget.
- The Balanced Budget. If your income is the same as your expenses, or, better yet, greater than your expenses, you have devised a fully-functioning working budget. Though it may be tempting to spend whatever "extra" funds you have, your next step ought to be to make sure that you put your leftover funds to work for you. There is no such thing as "money to spare," especially if you have debt or unrealized savings goals. Instead of adding your surplus to the "Fun" budget, always use it pay down your debt and add to your savings.
- The Unbalanced Budget. If you are spending more than you earn or receive, you have some serious work to do to balance your budget. Begin by examining and adjusting your variable expenses. You will need to pare back on this spending first by cutting back on luxury expenses, like restaurants, entertainment, and other non-necessities (e.g., brand-name products). If your budget is still out of whack, try cutting back on fixed expenses too. Perhaps you can rent a room or take on a roommate to share your bills. Or, maybe, you need to opt for a cheaper or more fuel-efficient car. Conversely, you can also try to increase your income by taking on part-time labor, working overtime (if it is available), switching jobs, or starting a home-based business.
- Evaluate continually. Your financial situation will change; therefore, it is necessary to make alterations to your budget from time to time. If you pay off a debt, get a raise, or make some other life change, rework your budget using your new information. And remember, debt repayment, savings, and financial security must always your number one priorities.