Planning is the key to success in any area of life, and this is especially true in the area of finances. That’s why a budget is so vital to your financial success.
First off, let’s begin by covering what a budget is not.
A budget is not simply “being careful” about your spending or living “frugally.” This is a good thing, but this is not as good as a budget. Why? Because a budget not only gives you spending restrictions, it also gives you savings goals.
- When I am frugal, I get more for less and will save money on purchases.
- When I budget, I have a clear plan for what to do with the money that is saved. Your budget gives you the “why” of your frugal lifestyle and the financial sacrifices that you make.
Secondly, a budget is not something that lives inside your head. A budget is not really a budget until it is written.
Finally, a budget is not simply looking back at your spending from last month. A budget tells your money for next month how it is going to be spent.
1. Identify monthly income.
Combine all income streams from both spouse’s to determine household monthly income. If you are self-employed and have an irregular income, either go with your average monthly income from last year or use your lowest income month from last year as the basis of your monthly budget.
2. Identify monthly fixed expenses.
Examples of monthly fixed expenses would include rent, mortgage, phone, cable, internet, car payment, life insurance, car insurance, health insurance, giving to your church or other non-profits, magazine subscriptions, video streaming subscriptions, music streaming subscriptions, etc.
Required vs. Discretionary
Next, you need to identify which of these monthly fixed expenses are required and which are discretionary.
Required expenses are things that you must have in order to survive. Discretionary expenses may be nice, but they aren’t necessary for survival.
You have to pay your rent. You don’t have to have Netflix (I know, I just rocked some of yall’s worlds with that shocker).
Many of us struggle with recognizing what is truly a required expense, and what is just a discretionary expense that we happen to really enjoy. As we will discuss in Step #6 when money is tight some of these discretionary expenses may have to get the boot.
I know some of these things have become woven so much into the fabric of our lives that we feel like they ARE required expenses. (“Get rid of Spotify!? How could I survive!?”)
But the first step towards financial independence is to honestly assess what your needs are vs. your wants.
3. Identify monthly variable expenses.
Again, you want to begin with your required variable expenses. Examples include utilities, power bill, food, and gasoline.
Next, move to discretionary variable expenses and complete the same process. Examples include clothing, entertainment, home improvement.
Set an estimated budget for each line item. For now, just make an educated guess. You’ll likely have to change some of these numbers in Step #6, so don’t spend too long on this step.
4. Identify all irregular expenses.
Not all expenses happen monthly. If you don’t plan for these expenses, they will end up crashing your budget when they come up (examples: car repairs, gifts, Christmas, car replacement, replacement of furniture, vacation).
Take a look at how much money you think you will spend in each of these categories in one year’s time. Then divide that number by 12. This is how much you want to allocate to that category each month.
For more information on planning for irregular expenses, check out our guide: The 5 Most Common Budget Busters and How to Prepare for Them.
5. Set financial goals.
In his book, Financial Peace, Dave Ramsey has created a financial process of “baby steps” that many people have found helpful for setting their financial goals:
- Baby Step 1- $1,000 emergency fund
- Baby Step 2- Pay off all debt but the house
- Baby Step 3- 3 to 6 months of expenses in savings
- Baby Step 4- Invest 15% of income into retirement
- Baby Step 5- College funding for children (this step is optional)
- Baby Step 6- Pay off home early
- Baby Step 7- Build wealth and give
6. Cut spending.
If you look at your budget, and you have more going out than coming in each month, you obviously will not be able to reach any of these financial goals. You will either have to increase your income or decrease your expenses. If you want to try to decrease your expenses, here are some ideas to help get you started.
First, cut back on your variable expenses.
Always begin with the items that you marked as variable expenses (food, clothing, utilities, power, home improvement, entertainment, gas). You are not receiving a monthly bill for these categories, so your spending is based on your consumption.
Can you decrease spending in any of these categories?
Next, cut back on your discretionary expenses.
Next, move to the fixed expenses that you marked as discretionary.
These are items that you are paying the same amount for every month, but they are not necessary for survival. Examples include internet, cable, phone, magazine subscriptions, video streaming subscriptions, music streaming subscriptions.
Which of these bills can you cancel or decrease your monthly payment through cheaper plans?
Finally, move to your fixed expenses that are required (examples: rent, mortgage, car payment, car insurance, home insurance, health insurance).
The average person is grossly overpaying for car insurance and home insurance. Why? Because they don’t shop these bills to get the best deal!
After you complete this “delete/decrease” process with all of your bills, you may find that you have more money than you think you have! And then guess what? You’re done!
Whew, thought would never end, didn’t you?
The good news is that the first month is the hardest month to budget, and then things get easier each month from there.
But there is no more important step in all the world to your financial success than building a realistic budget and sticking to it. So get going and start building yours now!