How to create a budgetDieting is hard. Even just thinking about the word brings negative thoughts because we compare it to giving up something we like to do. Some people have even relabeled it as a “nutrition plan” or “lifestyle change”. We can call it whatever we want but the basic formula is pretty simple. If you have been eating too much you will gain weight. You have to stop eating as much in order to lose weight. The same can be said about money. If you have been spending too much you are going to collect debt. If you want to lose the debt you have to quit spending so much. You have to do on a money diet. To me the word diet is not a scary word. It means a plan. On a diet you are still going to eat. When you follow a budget you are going to still have an income and you are still going to spend money. The difference in for each is how you eat or how you spend your money. To me the example is personal. In my early 20s I loved to exercise. I also watched what I ate very closely. Staying in great physical shape was my number one priority. Then I got married. I got hired into a great corporate job that required lots of hours. Then my beautiful daughter Brooke was born. Before long my priorities completely changed. Going to the gym and planning out my meals was on the bottom of the list. Who had the time? I began to just eat whatever was available and was quick. You can already guess what happened. Soon I realized I was far from the physical shape I had once been in and it was taking a toll not only on my body but my mind and energy. I was not controlling my diet; I had allowed my fast paced lifestyle to control it. There was a domino affect. I would feel tired more often so I would be less active at home. Being less active at home led to more maintenance problems that should have been taken care of. Seeing the chores go undone that I knew I was responsible for made me feel bad which only slowed me down even more. So I made a decision that I was not going to go any further with this. I got a diet plan and committed to following it. The first weeks are very hard as anyone who has gone through this will testify. However, you have to stick with it and you will start to see results. When you start seeing results you will feel good about yourself and be encouraged to try even harder. I was once on a diet that had you follow a strict plan 6 days a week. On the seventh day some of the restrictions were lifted and you were allowed more choices. The creator of the diet knew that it would be hard to diet and give up the foods you used to enjoy. However, if you knew that you would be rewarded with a break or a small treat on the seventh day you were more likely to keep to the requirements of the diet. I thought that worked well and I can see a correlation to following a new, strict budget. You create a budget because the old way of managing (or not managing) your money did not work. It is the same as going on a diet. You decided at some point you are not in the physical shape you want to be and you had to make changes in your diet. So you found a realistic diet plan and started following it. However, you find out that like most things it sure looked a lot easier on paper than it does in real life. It really takes discipline and determination to stay focused on following the diet. There are going to be times when it is tough to stay mentally focused so it is ok to give yourself a structured break every once in awhile. In the diet I mentioned the break on the seventh day did not mean you could eat as much junk food as you could get down in 24 hours! It meant you could have 1 or 2 small portions of your favorite foods on that particular day in addition to the regular diet. The same holds true with creating a budget. When we create the budget we put a small amount of money aside for fun. What is fun is up to you. The point is that the money is a small break from the discipline it takes to follow your budget every day. On predetermined days you will allow yourself to take that fun money and do what you want with it. It is your reward for following the budget. The following is a step by step guide to creating a customized budget for yourself. Everyone’s situation is different, but most of the theory applies to anyone.
Create a budget in 8 stepsCREATE A BUDGET / STEP 1 – LIST YOUR
NET INCOME The first step for creating your monthly budget is to determine what your net income will be. That is the amount of money you have left over after taxes and other pretax deductions are taken from your pay. If you are self employed you can make the same estimation on what you will have left after your tax responsibility is considered. Some people pay for some expenses prior to their paychecks being taxed. Those expenses can include health savings account, health insurance, flexible spending accounts for medical or daycare, dental coverage, and life and disability insurances. That will reduce your gross income. Once those deductions are taken out your gross income is taxed leaving you with your net income. That is what we will use for this budgeting example.
CREATE A BUDGET / STEP 2 – LIST EVERY EXPENSE NO MATTER HOW MINOR Before you begin writing the budget you should have kept a log of everything you spent money on. This is important because if there are several things you spend money on every month and you are not accounting for it your budget’s accuracy will be questionable. Refer to your bills, statements, and records during this step. You want to know what your expenses are and how much you are paying for them each month. Don’t guess unless you really have to. Refer to your checkbook, ATM and retail receipts, or even notes on your refrigerator if you have to for clues on how much you have actually been paying. Real numbers are important. For expenses that can vary widely like electric you should determine an average warm temperature bill and an average cold temperature bill. What is the average bill May through October and November through April? For now, if you are writing your budget in June you will go with the first average. When you first get started you may not have all the documentation you should in order to make 100% accurate statements about the amount of money you are paying for each expense. However, you should be able to make educated guesses since you are the one writing the checks! When you write down the amount you think you pay for an expense you should guess a little high. If you think you spend $15 a week on drycleaning write down $18. For our purposes it is better to have more money set aside for the expense than not enough. If you end up with more money set aside for a particular expense at the end of the month that is ok. We will discuss that in step 7. Once you have been on the budget for a month or two you can start adjusting these amounts to more accurately reflect what they truly are. Now that you know everything you spend money on every month (including things like church, charity, water at the gym, etc) and you know how much you are spending on each make two columns down a sheet of paper or on your spreadsheet.
CREATE A BUDGET / STEP 3 – “MINI ACCOUNTS” FOR FIRST PAY PERIOD Your monthly budget will be based on the number of times you are expecting income. You may be paid once, twice, four times or daily. Every monthly expense you have will be divided by that number and you will set aside an appropriate amount of money for each expense every time you are paid. For example – I get paid every Friday. There are 4 Fridays this month. My rent is $600.00 and will be due on the first of next month. Every time I get paid I will set aside $150.00 in preparation to pay my rent on the first of next month. That $150.00 will not be used for anything else. It is earmarked for rent, that is it. My electric is $70.00 a month. I need to set aside $17.50 every pay. My cable is $60.00 a month. I need to set aside $15.00 every pay. $60.00 divided by 4 pays in the month = $15.00 per pay. Lets say that you take your income and put it into a checking account once you are paid. Much like your home is partitioned into separate rooms we are going to partition your checking account into mini accounts. Most of what you own is in your house but not all of it is in the same room. The same will be true for your checking account. Each of the expenses you listed will have its own mini account. Funding for paying each expense is put into the appropriate mini accounts from the money in the checking account. Don’t worry. You will not be physically moving cash from your checking account into 35 different accounts! We will consider each mini account and the money we put in it as independent from all the other mini accounts. For example - you know that your rent is $600 a month. You are going to be paid twice this month. Under your Rent Mini Account you will list $300 this pay period. The money is in your checking account but on your budget it is listed in this mini account. That is your reminder that while you have a larger amount of money in your checking account $300.00 of it is not to be touched for anything other than rent.
CREATE A BUDGET / STEP 4 – “TOTAL IN ACCOUNT” At the end of the expense column on your budget you will have tally line that says “Total in Account”. Add up all the mini accounts for the income / pay period. That amount is listed in the “Total in Account” box. This is the amount that should be in your checking account. You allocated every dollar in your checking account into the appropriate mini accounts. Those mini accounts = the amount in your checking. This is the step that monitors your mini accounts for accuracy. This is what ensures your budget is balanced.
CREATE A BUDGET / STEP 5 – BALANCE THE BUDGET Balancing a budget may seem difficult for some, especially the government. It boils down to you can not spend more than you are bringing in. Period. If the money is not there it is not there. Making excuses about circumstances that required you to spend more than your income provided will only end up getting you in debt. Balancing your budget may call for creativity and sacrifice sometimes. I had a friend, Sean, tell me once the mini account plan does not work. I asked why. He had budgeted $70.00 for gasoline during the current pay period. He went on a long trip out of state to visit his parents. He ended up spending $80.00 on gas during the pay period because of the extra mileage from the trip. He was over by $10.00 and now his budget was unbalanced. Because the trip cost more than he was allowed to spend based on his budget he reasoned that the budget was a bad idea. The point he missed is that in order to remain financially sound he had to find a way to keep his gas expense under $70.00. If there were no alternatives to be found than he couldn't go on the trip. One of the beauties of monitoring your expenses, checking account, and mini accounts each week is that you have early warnings if there is going to be a problem. In Sean’s case he knew in advance he was going to take this trip, that he only had $70 in gas money, and that he would be driving a lot of extra miles this pay period. Before he took the trip he should have been looking at all of his mini accounts. He would have had some options to balance his budget. He could have reduced gasoline usage by cutting back on other trips during the pay period in order to compensate for the long drive to see his parents. He could have reduced some other expense by $10 an put that money in his gasoline mini account. Regardless of how he does it he can not spend more than he has in the budget.
CREATE A BUDGET / STEP 6 - “MINI ACCOUNTS” FOR SECOND PAY PERIOD Mini account funding during the second (and third if applicable) pay period is much like the first pay period of the month. You already know how much you have to add to your mini accounts every pay period. For example – My rent is $600.00. I get paid two times a month. I have $300.00 in my “Rent” mini account from the first pay period. I now add another $300.00 to it and am ready to pay my rent. During the last pay period of the month you review your expenses and your mini accounts. Due to your vigilance in controlling costs during the month you may find that you have more in a mini account than you need in order to pay the expense in full. That is money you can : add to other mini accounts because those expenses were higher than expected, keep in the mini account because you know next month will be a harder month and you will need that extra cash, use to buy assets that will prevent future costs, or put aside into an emergency cash fund.
CREATE A BUDGET / STEP 7 – WHAT DO TO WITH MONTHLY OVERAGES This is the easy problem to deal with! It is the end of the month and you have just paid all the bills. You match your mini account totals against your checking account balance and discover that you have more money left over then you had planned on. This extra money is not for spending on fun. In fact fun spending should be a mini account that has its own funding each pay period. Rather this money is to be put in an appropriate mini account. Perhaps you have $30 left over because the temperature has been warmer than expected and your heating bill wasn’t as high. You will take that $30.00 and add it to a mini account that is set aside for debt repayment. When it is time to make a payment on that debt you will be able to pay an additional $30.00. It is not a bad idea to make overages happen buy making it your goal to find a way to spend less than you were budgeted for a particular expense. Example – you have $50 in your “Dining Out” mini account. You found a restaurant that is giving away $50 gift cards this month for $25.00. You take this buying opportunity and get $50.00 in food and still have $25.00 left over to add to another mini account that will pay down debt for you – you could pay an additional $25.00 toward the principal amount owed on your home this month. The point is that the extra money is not spent on unneeded, unplanned expenditures.
CREATE A BUDGET / STEP 8 – WHAT TO DO ABOUT SHORTAGES How can a shortage possibly happen if you follow the budget? Use the heating example from above. Lets say the month turned out to be much colder than anyone expected. The heating bill will be higher than usual. You had planned on $130.00 for heating this month, but the bill came to $160.00. You know you are not allowed to spend more than what is in your mini account thus giving you an unbalanced budget. Using credit is not an option either. First of all you must balance that budget at the end of every pay period without exception. You are completely responsible as the administrator of the budget to take the amount of income you have and appropriately apply it to the number of expenses you have. I have two suggestions for you. Any overage you had in another mini account can be applied to the “Home Heating” mini account. That $25.00 you saved in your “Dining Out” mini account can be applied to heating in this case. You could also forgo dining out, take the entire $50.00 and apply it to the heat. One last option is to “borrow” the money in this extreme case from your “Emergencies” mini account to cover this month’s shortage. However, you are now charged with squeezing that money out of some other expense next pay period and paying that money back. The main thing to remember is that you should be doing this all within the budgeted amount of money you have from your income. Credit is not needed and shouldn’t even be an option on the table. You may have to get creative at times or even make some hard sacrifices, but it is your responsibility to budget the balance on real money.
Bowman’s Money College offers consulting and educational advice to individuals and families on personal financial matters such as starting a small business, writing and following a household budget, and rebuilding credit. For further information visit BowmansMoneyCollege.com or email mike@bowmansmoneycollege.com.
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