DEFINITION OF A BUDGET
If you want to gain more control over your spending and start working toward your financial goals, you need a budget.
A personal or family budget is a detailed summary of income and expenses expected for a defined period of time, usually for a month. While the word budget is often associated with restricted spending, a budget really should mean more efficient spending.
A budget will show you the amount of money you expect to contribute against all your expenses, from required expenses, such as house and rent payments, to pleasure expenses, such as entertainment. Instead of viewing a budget as a negative, you can view it as a tool to achieve your financial goals and avoid bankruptcy.
WHAT THE BUDGET DOES
As a personal financial planning tool, a written monthly budget allows you to plan how you will spend and/or save your money each month and also how to control your spending patterns. While budgeting may not seem like the most exciting activity (and for some, it’s downright scary), it’s vital to keeping your financial house in order, as budgets depend on balance. If you spend less in one area, you can spend more in another, or you can save that money for a larger future purchase, build a fund for a “rainy day” or even for retirement.
Before you start budgeting, it’s important to realize that to be successful, you need to provide the most detailed and accurate information possible. Ultimately, the bottom line of your new budget will show you where your money is coming from, how much is there, and where everything is going each month.
STEPS TO CREATE A SIMPLE AND EFFECTIVE BUDGET
Creating your first budget can be extremely overwhelming. So overwhelming, in fact, that only 15% of Mexican families have an active monthly budget. But it is worth the effort. Developing a budget that you can stick to for the long term has definitely been linked to building wealth, while at the same time helping you get out of debt and reduce your expenses.
When I built my first budget several years ago, I knew roughly how much money I was making annually, but I had never broken down my expenses by category to find out how much I could pay on a recurring basis or how much money I could pay regularly. Invest. Save money.
In short, you were spending money on the things you needed and wanted without first determining whether you could actually afford them. After emptying my checking account once or twice, and having to pay off multiple credit card debts due to my lack of budget, I decided to get real and start a budget.
If this is the first time you are making a budget, here are 11 steps to make the process as simple as possible.
- Determine how much you have
If you have savings, checking accounts, investment accounts, or any other financial instrument, you’ll want to know how much money is in each account, as well as the interest rates and expenses for each. Take note of this information as it will be important in determining your net worth and the best use of your capital in the future.
- Determine how much you earn
For some people, this is easier than others. Those wage earners can easily find their monthly income. For hourly employees or those who run a business where income can unpredictably rise and fall, this can be much more difficult. The most important consideration, regardless of how you earn your monthly income, is determining the average monthly amount of income you receive. A good way to do this is if you receive irregular income, it is to average the last 6 to 12 months of recurring income and use that figure. If you want to be more conservative, you can choose the lowest monthly amount you have earned in the last year, what you will have is the worst possible scenario.
- Determine what you owe
Determining your recurring monthly debt payments should be your next step. This should be fairly simple to do, as long as you have stopped incurring additional debt in the short term. If you haven’t been able to break your dependency on credit cards, that’s fine, as budgeting will act as a first step to your next debt relief. To find out what your recurring monthly debt payments are, calculate the total amount owed on each debt account, as well as the minimum monthly payment. This includes auto loans, mortgages, credit card debt, student loans, and all other debts that your family pays off on a monthly basis. This will provide you with the first items on your budget and allow you to determine your net worth.
- Calculate your net worth
Once you know how much money you have and how much you owe, you can easily determine your net worth. Simply subtract what you owe from what you have and you get a number. This number will tell you the value of your financial resources. For me, this number was revealing. When I built my first budget, I had a negative net worth. I suppose this is quite common in Mexico, especially for young people just starting out.
- Determine your average recurring monthly expenses
This can be the difficult part for many people. The best way to determine your monthly expenses is to make a list of your household expenses for one month. Keep your receipts, utility bills and any other expenses that arise for a period of one month, and divide these bills into categories. Categories can be as general or specific as you want them to be. I keep my categories extremely general (automotive / household), while you may prefer specific detailed categories such as (car wash / electric bill). Either way, it works fine, as long as you determine an average amount of expenses for each category.
- Enter this information in a database
Before, you used to make budgets on paper. Things have changed for the better for all the new budgets. Software programs like Microsoft Excel and online budgeting tools have made it much easier to take the results of your first steps and develop a highly adjustable and sustainable long-term budget. I use Microsoft Excel for my own personal budget, because it allows more flexibility than websites. However, many people trust online budgeting sites, and whichever path you choose, it will ultimately help you accumulate more wealth and help you stay out of financial trouble.
- Check the bottom line
After entering all of the above information, you will discover the most important number in your budgeting process: the totals line. This number will tell you if you are overspending or less. Ideally, during this step you discover that you live within your means, and maybe even have a little more left this month than the month before. On the other hand, you can determine what adjustments to make to your monthly expenses in order to live within your means.
- Make the right adjustments
If the bottom line of your budget shows that you are spending too much of your monthly income, you will reach the most difficult step: making cuts in your monthly expenses. There are many websites that will teach you to be smarter with your income, help you reduce your recurring monthly expenses, and set your financial limits for budget planning.
- Adjust categories based on reality
Life is full of surprises. Food becomes more expensive, gas prices rise, and rent can go up when you least expect it. Every time you notice that inflation increases in your expense categories, you get an increase in work and you start to earn more money, or worse, you suffer a financial setback such as a salary reduction or a job loss, you must adjust your categorical expenses according to the realities of the world around you.
- Pay yourself first
Depending on your budget, depending on your bottom line, you may want to add some additional items to your monthly expenses. These can be scattered monthly to a savings account, college savings plan, or other savings vehicle. Moving money into savings and treating it as a recurring expense will allow you to slowly build up your savings without feeling like you have to make these deposits of what is left at the end of the month.
- Track, monitor and be disciplined
Keeping track of your budget takes about an hour a week. But this will save you a lot of time in the long run. Once you have a budget in place, you want to keep it under control. The discipline and associated knowledge that you are making good short-term and long-term financial decisions will bring you great comfort and carry you from check to check with a long-term result of your savings