5 Steps to Creating a Personal Budget
Creating a personal or household budget isn’t the most exciting thing in the world. In fact, the word “budget” often garners a collective eye roll – and for good reason. Personal budgets are restrictive, and with a budget, you can’t spend your money freely. But if you’re looking to get a handle on your personal finances and you’re tired of being broke at the end of the month, a working budget can get you on track.
A budget is a spending plan that determines how much you will allocate to monthly expenses. This is an important aspect of financial planning, and an excellent way to assess where your money goes. Rather than focus on how a budget limits your spending, focus on how a budget can help you gain control of your personal finances.
Here are five steps to develop a personal budget that you can live with.
1. Know Your Income
The first step to developing a personal or household budget is determining how much you earn each month. Use a notebook or a spreadsheet program to track your money. Start by recording all your monthly income. This includes income from your employer, retirement income, unemployment compensation, disability income, child support, alimony and any other income source. If you’re employed, record your net income, which is your income after deductions.
2. Determine Your Fixed Monthly Expenses
Create a category for fixed monthly expenses. This refers to expenses that recur on a monthly basis. Fixed expenses include:
- transportation – car payment, car insurance, fuel costs
- utilities – electric, gas, water, sewage, telephone
- other debt/loan payments – student loan, car payment, personal loans
Create additional sub-categories as necessary. For example, you may have a category for childcare, association dues, etc. Assign a dollar amount to each expense in this category to determine your total fixed monthly expenses. Refer to last month’s statements for exact figures. Fixed expenses typically remain the same on a monthly basis. Gasoline and utilities may vary slightly from month-to-month. Track how much you spend in these areas for one or two months and estimate your monthly cost.
3. Subtract Fixed Expenses From Net Income
After determining your fixed expenditures, subtract this value from your net income to arrive at your discretionary income. This is money left for spending after you’ve paid necessary expenses. Discretionary income covers your monthly variable expenses.
4. Determine Your Variable Expenses
Variable expenses are costs that can change from month-to-month. The way that you manage these expenses is crucial to your personal budget. Some people earn enough to pay all their monthly expenses. However, they mistakenly spend too much on their variable expenses. This reduces their amount of available cash which can impact their ability to pay fixed expenses. Variable expenses include:
- entertainment/recreation – movies, dining out, etc.
- personal saving (about 10% of your income)
- miscellaneous expenses – hair appointments, nail appointments, lawn care, car washes
Once you determine your discretionary income, decide how much you’re able to spend in the above sub-catergories. This is one aspect of budgeting that many dislike. It forces them to be realistic and responsible with their spending.
Let’s say you have $1,000 in discretionary income each month, your budget may look like this:
- groceries – $400
- entertainment/recreation – $250
- personal saving- $250
- shopping/miscellaneous expenses – $100
Subtract your variable expenses from your amount of discretionary income. A good working budget is when your total expenses (fixed and variable) minus your total income equals zero. If there is a surplus after assigning a value to each category, allocate a higher amount to personal savings. But if you have a negative balance after assigning a value to each category, reduce how much you spend in certain categories.
When calculating your variable expenses for the month, take into consideration one-time or extra expenses that may pop up during the month. These can include gifts, car registration, a car repair and other costly purchases. Staying on budget sometimes requires modifying how you spend your discretionary income. For example, if you have an extra $200 in expenses one month, maintaining your original budget will result in overspending for that month. You can avoid this by spending less in categories such as groceries and entertainment to compensate.
Another way to stay on budget: regularly track your spending throughout the month. A budgeting worksheet is an excellent tool for monitoring how much you’ve already spent in each category, thus allowing you to reign in spending if there’s a risk of going over budget.
Some people find it helpful to track their spending on a weekly basis. For example, you might use the envelope method. Have an envelope for groceries, entertainment and miscellaneous expenses, and each week, put cash in these envelopes. It is easy to overspend when you rely on credit cards or debit cards for purchases. But with cash, you’re limited to the specific dollar amount inside your envelope.