Personal Finance 101: How To Create A Budget
Not being able to stick to a budget is a major reason people get into debt. And once you’re in debt, it’s an uphill struggle to climb out of it, as you work harder and harder to pay back growing loans.
Sticking to a budget may not be fun, but it sure is smart.
Forecasting your income and expenses means you’re less likely to spend money you don’t have. And by living within your means, you won’t slip into debt, or you’ll be able to pay back any borrowing.
As simple a tool as it is, the budget is essential for gaining control of your finances and building wealth.
If you’ve never budgeted before, today’s post will show you how to create a budget in just five, easy-to-follow steps.
Step 1: Calculate Income
It’s important to get certainty over your income, as first and foremost, you need to know that you have enough to cover your living expenses.
Tally up all the income your household receives, starting with your own wage.
This may be simple if you’re on a salary and your income doesn’t change month to month. But if you’re paid hourly or self-employed, it can be trickier to nail down, and you may have to estimate the hours you’re expected to work or allow for expenses or tax to be deducted first.
Don’t forget to include all other sources of income such as benefits, investments, savings interest and side hustles. And also include your significant other’s wage if you’re in a relationship – I’d suggest budgeting as a household if you’re sharing bills.
Step 2: Gather All Your Financial Commitments
Once you know how much you’re going to make, you then need to estimate how much you’re likely to spend.
If you have no idea, then I’d suggest you start tracking your expenses going forward and getting clued-up on your money.
But to get an instant idea of your spending, log into your online banking and review past bank statements. Download or print your last three months to get an average of your spending.
Annual and Quarterly Bills
You will also have to prepare for bills that don’t occur regularly, such as insurances, subscriptions and taxes. Search your emails, letters and bank statements for previous invoices, and if you don’t already, start keeping track of when things like your MOT and home insurance are due for renewal.
Budgeting for Maintenance and Repairs
Budgeting for home maintenance and vehicle repairs is tricky as these costs can vary significantly from year to year or come up completely unexpectedly.
To make sure you don’t get caught out with these irregular expenses, check what it’s cost you to keep your home or car running the past year (or several years if you know), and then divide that number by 12 to get an amount to squirrel away each month. If you don’t have past data, then estimate the costs as best you can.
But make sure you’re setting aside something for maintenance as every home and vehicle suffers from wear and tear.
I would also suggest saving your maintenance fund with a different bank other than the one you have your current account with so there’s no temptation to dip into it.
Create A Spreadsheet
Once you have all your expenses to hand, create a spreadsheet to break them down into the major categories as shown below.
Having your expenses neatly laid out allows you to clearly see where your money is going, but more importantly, it allows you to easily spot money-saving opportunities.
Step 3: Set Your Budget
With certainty over your income and living costs, it’s now time to set a realistic budget.
With your expenses to hand, plan for everything you’re going to spend the upcoming month:
Now is also the time to look for ways to save money. Approach saving in two ways: what you can do in the short term, and longer changes to cut money pits and move you closer to your dream lifestyle.
How quickly you wish to save or pay down debt will determine how ruthless you’ll need to be with your budget.
I’m rather cut-throat when it comes to eliminating expenses, and I’ll get rid of anything that I don’t use often, or that isn’t adding value to my life.
If you cut something and find that you actually do miss it, you can always add it to your budget again.
So, ask yourself; what have you spent money on recently that you didn’t think was worth it?
What could you cut from your budget entirely and not miss? What about a hardly used gym membership? Or a magazine subscription you never get around to reading?
And what else could you do to save more? Perhaps eat out less? Workout at home? Switch utility or broadband providers?
Once you’ve scored some quick wins, it’s time to start looking at plugging the drains on your cashflow. Most peoples three biggest living costs are their housing, transport and groceries.
Making changes in these areas is difficult because of the impact on lifestyle. However, it is also where the most significant savings can be made.
If, like me, you dream of becoming financially free at a young age, big changes like moving into a smaller place nearer work and going carless should be considered.
And even if your financial ambitions aren’t as grandiose, it’s still worth considering how much you could save by making smaller changes to the big three.
In contrast to short term savings, I would consider any long-term changes carefully as their not as easily reversed.
Step 4: Automate Your Surplus
This step is often missed from budget advice but is crucial if you want to build wealth.
Hopefully, you’re running a surplus budget, meaning there is money left over after you’ve covered all your living costs.
If you’re spending more than you earn, you have a financial emergency which should be treated like your hair’s on fire. Stop spending on anything that isn’t critical to your survival and prioritise paying back debt.
But if you have “disposable income”, DON’T BLOW IT! You have an amazing opportunity to build wealth and passive income.
Any surplus income should be used for:
- Debt – pay off the loan with the highest interest rate first.
- Save – build a rainy-day fund for emergencies and set up savings accounts for one-off life events.
- Invest – put your money to work.
Set up a standing order so that you’re automatically paying off debt, saving or investing (in that order) with any surplus income.
Step 5: Monitor Your Spending
Creating a budget is not a set and forget exercise. Once you’ve established your budget for the month, you must review it weekly (or more frequently if required) to ensure you’re going to come in on or under your target in each category.
Keep track of your spending using a notebook, spreadsheet or budgeting app – whichever you find most convenient.
If you’re going to overspend, then you’ve got to do what you can to adjust your spending.
This isn’t always easy. It takes discipline and willpower to stick to a budget. You’re going to be faced with temptations to part with your cash daily. But you’ve got to remain strong and keep focused on the bigger reasons as to why your budgeting (getting out of debt, buying your first home).
If you find that you’re always over budget, you may have been too ambitious when setting your budget. No stress. Go back to the drawing board and see where you can cut yourself some slack.
Sticking to a budget can be difficult in the beginning, and it takes a bit of trial and error to nail it consistently.
The Final Word
There’s a hesitancy about starting budgeting due to the perception that it will zap all the fun out of life. But budgeting isn’t just about cutting. It’s about being aware of your spending and making sure that the money you work so hard for is being used as efficiently as possible.
Budgeting is a vital life skill, but unfortunately, it’s one most people have to teach themselves. Hopefully, this post has provided you with the knowledge to create a budget that will help you reach your financial goals.
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Hi! I'm Jamie
I’m a 30-something money blogger that writes about saving, frugal living, investing and entrepreneurship.
I’m currently working towards FIRE (Financial Independence Retire Early). If you share the same desire for freedom and you’d like to escape the 9 til 5 and spend your days however you want, then you’re in the right place.
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