Would you prefer to listen to a podcast on this topic? This week's Financial Beeswax episode discusses Creating a Budget.
Creating a budget can seem overwhelming. You may wonder how do we start? What categories should we use? How much should we allocate to each category? The following are some steps to get you started.
First, before getting started, decide what medium you are going to use to manage your budget. For example, will you use Excel, Numbers, a hard-copy budget book, Quicken, or an app. There are a variety of options, and it’s best to pick the one that you will want to use and not what others like using.
Second, use historical spending and income to create a rough draft of your budget. Take all transactions or spending for the past 12 months and enter them into a spreadsheet. It will be much faster if a program such as Quicken, Numbers, or Excel is used. Separate columns by month. Create categories such as putting all purchases for clothing into a clothing category. Your categories will be created by the transactions you have made over the past year.
Make sure to include all spending such as credit cards in addition to a credit card’s monthly minimum payment. Don’t leave out credit card purchases. The reason is if you are using credit cards as a source of cash for monthly purchases, your budget will not accurately reflect your monthly purchases. You want your budget to reflect all purchases you make each month.
Make sure you have entered your monthly net income at the top. Do not use gross income. You want to use the money you actually receive in your paycheck to create your budget. You cannot pay bills with the money that is deducted from gross wages.
Next, calculate total income and total expenses for each month in each column. Then subtract the total expenses from total income. Look at each month and see which months have a deficit and which months have an excess.
Then, total each row of categories for the 12 months and divide by 12 to obtain an average. This reflects the average of how much is spent each month in each category in the past year. Income may need to be averaged if it fluctuates due to bonuses and commissions.
Now, if you want to get really detailed, you can calculate the percentage of each category to income. For example, if your monthly net income is $1,000 and you spend $200 a month on groceries, your groceries expense would be 20% of your income. Category percentages vary based on where a person lives and individual needs. Different websites offer a variety of opinions on category percentages. You can research blogs, look at your budget, and see what works best for your situation.
Once you have your average income and spending for each category for the past year, you have a rough draft of your budget. This rough budget may look great or not pretty at all. More expenses may be going out than income coming in. That’s not a good feeling. If more is going out than coming in, adjustments need to be made to the budget.
I don’t recommend zeroing out a category. For example, I don’t recommend putting a zero for eating out unless it’s absolutely necessary to make the budget balance. Budgets that cause a person or couple to go cold turkey in an area will usually fail. It’s better to ease into big changes. For example, if $200 is spent each month on entertainment and you want it to be $50, adjust the amount down by a set dollar amount one or two months at a time. If the budget allows, of course.
Some budgets may need drastic cuts in spending. In those cases, it will take dedication to follow the budget as it won’t be easy to live with large limitations on spending suddenly. In this situation, it would be helpful to understand the “why” in the spending habits. For example, is there an emotional need being met when spending? Some call emotional spending “retail therapy.” Learning what triggers unhealthy spending habits helps us figure out how to change the way we spend.
Once the budget reflects total monthly income equaling total monthly expenses, it’s time to try it out. Each month, check your spending against the budget. How did you do? Were you able to follow the budget? Do you need to make changes to the budget? If you only look at the budget and do not compare your transactions with the budget, you won’t identify weaknesses and strengths in the budget and spending habits. It will be difficult to make beneficial adjustments.
If you mess up, don’t give up, just do better the next month!