Budgeting is the key to proper money management. Most people don’t create a budget because they think it’s tiresome and limits how they spend their money. In reality, budgeting is useful for tracking your income and expenses.
How would you like to hack your finances with a killer budget? It would put an end to most of your problems and improve your financial situation.
Forget the bad rap you might have heard about budgeting. You don’t need a strict budget to achieve your financial goals. It’s possible to be on a budget and still have a little fun from time to time. That’s my aim for you here!
This article will guide you on how to create a budget that works.
7 Simple Steps to Create a Budget That Works
It’s easy to get lost in your finances. Below are the steps on how to create a budget and learn better financial management for beginners.
1. Set Specific Goals
What do you want to achieve from budgeting? It helps if you have a detailed answer to this question before you begin creating your budget.
Most of the time, the goals of financial management revolve around saving, investing, or spending money on something within a particular period. If you’re specific enough on what you want, your budget will clear the way toward making it happen!
Let’s say you want to save money for a new car. It’s best to decide on a specified model and work toward meeting the price. It’s challenging to track your progress and be productive when you have random goals.
Don’t make the mistake of only budgeting to “free up some cash” without knowing how to put it into use. You might be successful at freeing it up, but there are high chances of the extra money going into fun activities and other unnecessary expenses. And that’s no progress at all!
Look at these tips on How to Set Financial Goals and Actually Meet Them.
2. Gather All Your Financial Records
Your financial records are essential for creating a successful budget. You want to be sure that everything you put down aligns with these documents.
They include the following:
- Bank statements
- Credit card statements
- Utility bills
- Insurance policies
- Mortgage contracts
- Retirement and investment statements
The more documents you can find, the easier it becomes to structure your budget. You should always store your important financial records somewhere safe for future reference. This way there’ll be no more guesswork when making significant financial decisions.
3. Find Your Net Income
In this step, you need to find an exact figure for your monthly earnings. Your income reports come in handy in this case. They show you all the money coming in and hence, how to create a budget that works.
Keep in mind that it’s the after-tax income and not the total salary that we’re talking about here. This income is what remains after federal, state, and withholding taxes have been applied.
If you’re employed and usually receive a regular paycheck, it’s easy to find your net income. You can add any automatic deductions back to the after-tax amount and put down the associated expenses in your budget. These deductions include money payable on 401(k) plans, insurances, and savings.
As for your other income streams, such as part-time jobs, you only have to deduct any applicable taxes and business expenses. It’s best to use the lowest monthly earnings you’ve ever gotten within the past year. This approach increases the accuracy of your net income and therefore, your budget.
4. List Your Monthly Expenses
You need a comprehensive list of everything you pay for each month. Most monthly expenses occur in the following categories:
Review your bank statements, credit card bills, recent utility bills, and receipts from the past few months to get a clear picture. If you have any credit card debt, student loan, or personal loan, add them to the list. Be sure that it’s the monthly payment on the debt balance and not the whole balance.
Savings are also an essential part of a budget. A good saver doesn’t save money as an afterthought. Setting aside a particular amount that goes into savings is crucial for achieving financial success.
You can include debts and savings in the categories they fall, such as housing or transportation. But don’t double-count anything!
5. Determine Your Fixed and Variable Expenses
First, you should determine your fixed expenses for each month. These are the expenses that remain constant over a long period.
It’s improbable that you’ll find a chance to cut back on your fixed expenses, but having them on your budget shows you where your money goes month after month.
They include the following:
- Rent payments
- Utility bills
- Loan Payments
- Car, house, and health insurances
Next, find out your variable expenses. They’re the ones that change from one period to another. Depending on your consumption, you can find something to slash a bit and put the extra money toward savings, investments, or debt payment.
Bear in mind that the term “variable” comes from the act of fluctuating and doesn’t mean that the expense is unnecessary.
Variable expenses include the following:
- Car maintenance
- Household maintenance
If you find it challenging to come up with an amount for any variable expense, calculate the cost for the past year and divide it by 12. It’s also good to prepare yourself for the next few months. This approach saves you from financial disaster in case a variable expense becomes higher than expected.
6. Calculate Your Monthly Income and Expenses
Once you have the totals of your income and expenses, work out the difference between them. Lower expenses and higher earnings mean that you’re good to go. You can save the extra money or put it into meaningful investments.
On the other hand, higher expenses and lower earnings indicate that you’re overspending and must act fast. If you find yourself in this case, you can either start generating more income or reduce your spending.
Most of the time, it’s much easier to cut down your expenses than to find a high-paying side gig or start a successful business overnight.
7. Change Your Spending Habits
If you’re spending more than what you earn, you have to adjust your expenses and allow room for achieving your financial goals. This is key to mastering creating a budget. The same applies if you feel like your expenditure doesn’t suit your path to financial freedom.
Most of us spend money on non-essential things from time to time. It could be dining out, buying new outfits, or going on vacations. What if you could replace all that with cooking at home, only buying clothes for special occasions, and going on staycations?
Figure out the expenses you can eliminate and those which you can skip for some time. It’s best to start slowly by getting rid of one unnecessary expense at a time. Within no time, you’ll be able to live without them and allocate your money to other useful things.
The 50-30-20 Budget Rule
Now that you know the basics of how to create a budget, the next step is to know how to reach your financial goals. Below is a guide on how to use the 50-30-20 budget rule to reach your financial goals faster.
1. Spend 50% of Your After-Tax Income on Your Needs
The 50-30-20 budget rule states that you should limit your needs to 50% of your after-tax income.((The Balance: The 50/30/20 Rule Thumb for Budgeting)) These include all your monthly expenses—fixed, variable, and non-essential expenses.
You should determine all the expenses that you deem “needs.” In most cases, they’re the ones you necessitate. Forgoing them has significant impacts on your life. For instance, housing, utilities, and groceries fall under the category of needs.
2. Spend 30% of Your After-Tax Income on Your Wants
Your wants are the things you desire, but you can live without them. Don’t start thinking about trips, high-end restaurants, and beautiful clothes yet. You may want to fix the “little things” that bug you before you go into luxury.
How about repainting your house, doing cosmetic repairs to your car, or upgrading your home Internet? The list goes on. You only have to picture your situation and find out what your meaningful wants are.
3. Spend the Remaining 20% on Savings and Debt Payments
The least percentage of your after-tax income that should go toward savings and paying debts is 20%. You shouldn’t only allocate the amount that remains at the end of your budget to these purposes. If any extra cash comes up after you’ve applied the 50-30-20 budget rule, put it into savings and debt payment.
Budgeting is a financial habit that comes with many benefits. One of the best benefits of budgeting is that you get a chance to take control of your finances.
With proper money management, you can be debt-free, pay bills on time, and save more money.
Now that you know how to create a budget, you better start making one!