A Budget is a spending and savings PLAN based on an individual or business's expected income and expenses over a period of time. Creating a budget allows you to compare your financial resources with your financial needs, and serves as a blueprint to financial success.
How does it help?
•Avoid wasting money
•Sets priorities for spending
•Keeps track of your money
•Plan for the future
A budget provides a roadmap for allocating resources, controlling spending, making informed decisions, and achieving financial success. By following a budget, you can reduce stress, improve financial success, and plan a more secure financial future. In this article, we will discuss the 5 steps to creating an effective budget. This article also includes some helpful tools that make budgeting a breeze.
Step 1: Set Goals
All financial plans begin with setting goals. Think about your personal situation and create a few SMART goals that will help you better understand your budgeting needs.
You will also want to think about how long this budget should be developed for. Most financial experts recommend creating personal monthly budgets, in which you create a plan for your money that goes from the first of the month to the end of the month. However, you could create a daily, weekly, or yearly budget as well. You could even create a special budget for something like a vacation or a wedding. This is something to think about before you move to step 2.
Step 2: Estimate Income
To kick off your budget, you will want to estimate how much money is coming in. For monthly budgeting purposes, income consists of both "earned" and "unearned" income
Earned Income: Money received from working (Salary, Wages, Commission, Tips, etc.)
Unearned Income: Money received from sources other than working (gifts, dividends, capital gains, social security benefits, pension, lottery, etc.)
Include both of these types of income in your budget, and remember to account for any overtime or extra pay you will be receiving.
Quick Note: On a personal monthly budget, you should always use your Net Income. (money after taxes and deductions)
Step 3: Plan for Savings (Pay yourself first!)
One of the most important steps in budgeting is to create a regular plan for savings. Not only will savings make it possible for you to meet future wants (down payment on a car, house, etc.), but they also act as an important safety net in your financial journey.
Most financial experts recommend an "emergency fund" of at least 3-6 months' worth of living expenses. This emergency fund protects against major life changes such as the loss of a job, and also protects against unexpected items you didn't budget for, such as a car repair, hospital bill, etc.
In this step of your budget, it is important to create a plan for savings. Even if you are at the point in your life where you have an established emergency fund, a plan for savings will still help you with future goals such as a vacation, a house, or retirement. You could even put this money you are saving into an investment vehicle, just make sure you have your emergency fund established first.
Most experts recommend saving 10%-20% of your income before spending money in other areas. This means you ideally would take 10%-20% of your income (or even more if you're comfortable) and move it to a savings account before paying any bills.
“Paying yourself first means saving before you do anything else,” says David Blaylock, CFP® with LearnVest Planning Services. “Try and set aside a certain portion of your income the day you get paid before you spend any discretionary money. Most people wait and only save what's left over—that's paying yourself last.”
This is not to say that paying your bills isn't important. In the next step of our budget, you will want to create a plan for paying bills and debt. However, by paying yourself first, you are ensuring that the most important item in your budget (your own financial future!) is accounted for.
Step 4: Estimate Expenses
In step 4 you will need to estimate how much money will be spent over the course of the month. Sometimes this can get a little tricky, so it can be a good idea to break your budget down into two larger categories; Fixed and Variable Expenses.
Fixed Expenses: Expenses that remain the same each month (rent, insurance premium, cable bill, etc.)
Variable Expenses: Expenses that change month over month (grocery shopping, entertainment, dining out, etc.)
Fixed expenses will be easier to add to your budget since you already know exactly (or have a very good idea) how much they will cost. For example, if you pay $1400 per month in rent, go ahead and write that into your budget.
Vibrable expenses are a little more tricky. You may be asking yourself; how much should I write in for grocery shopping? For your first budget, you may have to make an "educated guess", though it would be very helpful to look over your bank statement and analyze how much money you typically spend in this category. As you create more and more budgets, you'll begin to notice patterns and be more accurate when estimating variable expenses.
Step 5: Balance the Budget
After you have completed the first 4 steps, all that's left to do is balance your budget. To do this, first determine the total amount of income, total savings, and total expenses in your budget. Then follow the basic formula below
Formula: total income – total savings – total expenses = net amount
After calculating this, you may find that you have a budget surplus, a budget deficit, or neither.
Budget surplus – income is greater than expenses and saving – you get a positive number for your net amount
Ex. If your income is $2500, your savings is 200 and your expenses are $1000. You have $1300 leftover or a budget surplus of $1300.
This extra income is sometimes called "discretionary income"
Budget deficit – income is less than expenses and savings – you get a negative number at for your net amount.
Ex. If your income is $2500, your savings is 1000 and your expenses are $2000. You are negative $500 or have a budget deficit of $500.
Either way, if you end up with a budget surplus or a budget deficit, you will need to go back and edit your budget. Ideally, you want your net amount line to be the number "0". This is because your total Income should equal your total Savings + Expenses. This is sometimes called "Zero Based Budgeting", which simply means that every dollar in your budget has a purpose.
Think about it, if you have a budget deficit, you are losing money each money. Obviously, this is a recipe for disaster. You may need to adjust your savings or expense numbers.
On the flip side, if you have a budget surplus, you have extra money to spend! While this is a good problem to have, you want this money to go somewhere on your budget. Put your extra money into your savings category, or even splurge on some extra expenses if you wish.
Bonus Step 6: Track your Budget and account for Budget Variances
A Budget Variance is the difference between what you planned on your budget and what actually happened in real life. At the conclusion of the budgeted month, it is always a great idea to go back to your budget to see what you planned accurately and where you were a little off.
In each budget category, mark if it was a Favorable variance (earn more, save more, spend less ) or an Unfavorable variance (earn less, save less, spend more).
Using this system will allow you to keep track of your money, see areas you need to improve, and become a better budgeter each month! It is important to keep track of your budget and make the necessary adjustments each month to reach your goals.
Tools to help on your budgeting journey
Now that you know the 5 steps of budgeting you may be asking yourself "How do I get started"
There are many budgeting tools out there that help to make budgeting a breeze. You can try using budgeting resources such as Mint or Empower which will do a lot of the tracking and math for you. You could also build your own budget using spreadsheet software such as Microsoft Excel or Google Sheet, both of which have many free templates. Or you could also just do the old fashion way of pen and paper.
Final Thoughts
Mastering the art of budgeting is a powerful skill that can transform your financial well-being and set you up on the path to wealth. By following the steps outlined in this article, you can take control of your finances and pave the way to a bright future ahead! Remember everyone's budget will look a little different, you just want to make conscious choices that align with your values. So start today, and let the power of budgeting guide you toward financial freedom.
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