How to Create a Budget: A Step-by-Step Guide to Effective Financial Planning
Creating a budget is an essential step towards managing your finances effectively. A budget is not a “money diet” but a tool you use to understand how you earn, spend, and save money. It can be used to help you plan for both regular and unexpected expenses, like a speeding ticket or broken fridge; and if you have irregular or seasonal income, it can help you plan your cash flow so you’re not repeating a debt accumulation and payoff cycle.
So how do you know how much to spend on each type of expense? It’s actually simple once you learn how to break out your expenses into needs, wants, and saving. A good rule of thumb is the 50-30-20 budgeting rule (great detailed info and calculators here). Here’s the high level breakout of how it works:
50% of net income is spent on things you need
30% of net income is spent on things you want
20% of net income is saved
Once you determine your expense breakout, you can start creating a budget. To start, I recommend using a spreadsheet or good old pencil and paper. We provide all clients with our Simple Budget Spreadsheet that we work on together through Google Sheets; there are tons of templates out there to try. Once you’re ready to get started, here are simple steps to create a personal household budget:
Set your budget goals. Determine your financial goals, such as saving for a down payment on a house or paying off credit card debt. These goals will help you determine what is most important to spend money on, and what isn’t.
Determine your net income. Calculate your total income for the month, including your salary, bonuses, freelance income, or any other sources of income.
List your expenses. Make a list of all your monthly expenses, including fixed expenses such as rent/mortgage payments, debt minimum payments (loans/credit cards), utilities, and transportation costs, as well as variable expenses such as groceries, entertainment, and travel.
Categorize your expenses. Categorize your expenses into essential and non-essential categories. Essential expenses are those that you need to pay every month, while non-essential expenses are those that you can cut back on if needed.
Allocate your income. Allocate your income to each expense based on priority and importance. This means putting the dollar amount for your budget limit for each expense, and ensuring every dollar has a purpose. Start with your essential expenses (needs) and then allocate money to non-essential expenses (wants).
Track your expenses. Keep track of your expenses throughout the month to ensure that you are sticking to your budget, and to see where your money is going. You can do this with pen and paper, a spreadsheet (we provide our clients an Expense Tracker spreadsheet), or an app from a reputable developer like Mint or Simplifi. If you have your own business or spend your own funds on business expenses, you can even use accounting software. I really like Wave Accounting, which is free.
Adjust your budget. Review your budget at the end of each month and make adjustments as needed, to ensure you’re working towards your financial goals. You may need to adjust your budget if you overspent in one category or if your income changes.
Creating a budget is only the first step towards having control of your money and ensuring it’s working for you the way it should. To achieve your financial goals, you will need to stick to your budget and make adjustments as needed. Use your budget as a guide; it can be updated as circumstances change.
Need help with preparing and sticking to a budget? Schedule a free consultation with Journey Financial Wellness to get started.
