For most people, the word “budget” conjures up thoughts of penny-pinching and the unpleasant task of crunching numbers. This couldn’t be further from the truth. A budget is the cornerstone of a solid financial foundation and it can help you create a brighter money outlook. Making a budget isn't difficult either if you know how to approach it.
What Is a Budget?
A budget is simply a breakdown and plan of how much money you have coming in and how much you have going out each month. Could you imagine a business becoming successful if it didn’t keep track of its income and expenses? The same holds true when it comes to your personal finances. Without a clearly defined budget and a plan for managing your spending each month, your road to financial success could end up being a lot bumpier than it needs to be.
The biggest fear that most people have when creating a budget is that they will need to suddenly cut back on all of the fun spending—things like the occasional coffee or dinner out, movie night, or even the trip to Grandma’s for the holidays. This is the wrong way to think about your budget. In reality, a budget is a tool, not a punishment.
While you may find that you do need to cut some spending after putting together a budget, without actually sitting down and creating one, it is impossible to know what expenses need to be cut, if any. However, you shouldn't allow the fear of having to curb your spending a little stop you from taking control of your money.
Start With Your Income
The first step in making a budget is to determine how much income you have each month. This is quite easy and typically only requires you to take a look at your pay stub. Of course, if you’re married, be sure to include your spouse’s income as well. In addition to your regular pay, you’ll want to also include any other sources of income you may have, such as dividends, interest, a side business, and so on.
But what if you're a freelancer or run a business and you don't always receive a regular weekly or biweekly paycheck? In that scenario, you'll need to use the law of averages to determine your income. Look at your income for the past year, then calculate the monthly average. This can give you a baseline income amount for shaping your budget.
Tracking Your Monthly Spending
The other half of the budgeting formula is adding up all of your expenses for the month. Start with the regular and fixed payments you have, such as your mortgage or rent, car payments, insurance, debt, and taxes. For most people, these are going to be relatively fixed, meaning you can’t easily change the amount that is due each month. That's good, though, because it can make planning your budget easier when those costs don't fluctuate widely.
After you’ve listed your fixed monthly expenses, it's time to dig deeper to find out where the rest of your money goes. Take out your checkbook or pull your latest bank statement to help you with this step. Jot down how much you spend on things like utilities, groceries, entertainment, subscriptions, and so on. A monthly budget worksheet can help you with keeping track of expenses.
Another option for tracking your spending is syncing your checking account or credit cards to a budgeting app like Mint. The app automatically records your purchases for you and you can manually enter cash purchases or withdrawals from your bank account. You can also use the app to create your budget and set savings goals.
Creating Your Budget
Once you have your income total and your expense total, the next step is relatively easy. You simply subtract your expenses from your income.
Ideally, you should have money left over once all of your expenses are deducted. This isn't money you should just spend, however. This money can be used to build your emergency savings fund, pay down debt, or fund another financial goal.
Don’t worry if you have a negative number the first time you do your budget calculations. The whole reason for creating a budget is to identify deficiencies and find out how to address them.
Maybe this means cutting back on one of your magazine subscriptions, eating out one time less a month, or even just hitting the matinee instead of the prime time movie. Typically, just saving a few dollars here and there can be enough to not only make sure you spend less than you earn, but also apply a few extra dollars to things like high-interest credit card debt or your retirement savings.
Remember to review your budget each month and take into account any changes in your income or expenses. Your budget should be designed to evolve as your financial situation evolves, so you can create a healthier bottom line.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.