This week I'd like to go over making a monthly budget. A budget allows us to track our income and expenses. It is imperative to understand a few fundamentals about budgeting before we begin crafting our budget. Here are our key components for our costs and income.
What is a budget?
In regard to personal finance, a budget is an estimation of income and expenses over a specified period of time and is usually re-evaluated and adjusted periodically. Budgeting isn’t exclusively for lower-income individuals; budgeting is extremely useful for everyone even high earners with plenty of money in the bank. This is because budgeting ensures that your cash flow stays in the positive meaning you are using less money than you are earning and allows you to pay everything without accruing unnecessary debt.
An expense is the cost required for something. In this article, we will separate expenses into 2 categories which are fixed and flexible. When budgeting it is important to understand which expenses are most important to you in the event you don’t have enough income to pay for them all. The importance of each expense is different from person to person, however, if you need help deciding which expenses to cut consider listing all of them in order of importance to you and cutting some of the ones at the bottom of the list.
Fixed expenses - Fixed Expenses will stay the same each billing cycle. Such as rent, insurance, and debt.
Flexible expenses - Flexible expenses will differ each month, such as groceries, utilities, and entertainment.
Income is defined as any money received, especially on a regular basis, for work or through investments. There are three main types of income:
Earned Income - Earned income is money made from work that requires your time. This income is the money you receive from actively working. You work, and you get paid for your work.
Portfolio Income - Portfolio income is money you receive from selling an investment for more than what you paid for it. Portfolio Income is also known as Capital Gains.
Passive Income - Passive income is money generated from assets you own, where you are not actively working. Ex. Rental income, business income (as long as it's not earned based on time and effort), creating/selling intellectual property (e.g., books).
Evaluating our finances
It's a smart move to assess our finances periodically if we are planning a major purchase, or if we expect a significant change in income.
These four steps will help us achieve our monthly budget.
Finding our total income -
We will need to find our total revenue to create our budget. Total income includes household income, pensions, bonuses, and any take-home pay you expect to get during a month will go here. An important tip when calculating this is to make sure you use your net income and not your gross income which has yet to have taxes taken out.
Estimating our expenses
First, we see how much we spent on each individual item and decide if it is a fixed expense or a flexible expense. Our fixed expenses can be recorded into the budget right away. Since our flexible expenses such as electricity, water, gas, and food are not the same each billing cycle and can change from month to month we will need to estimate how much these will cost. Once you have an estimation for each of these, we recommend that you add 25% to your estimated number to account for any abnormality that may occur. If you have trouble creating an estimate, consider referencing previous billing statements and creating an average for the expense over the past 3-6 months.
Subtract our totals
We recommend that you use our free budget spreadsheet that you can download below. However, you can do this with pen and paper as well. Subtract our expenses from our income and what we have left is called our net balance. So, if we ended on a positive number, we have some leftover disposable income. Our disposable income is what we can spend on leisure actives or save for a rainy day. If we ended with more expenses than income, do not worry, we will help you here. Check out our guide to getting your monthly budget back in the green.
Analyze our data
Once we create our first budget, we can analyze our results over a few months. This step is an essential part of getting our finances under control. Here are a few questions we can ask about our month to month data.
Are we sticking to our monthly budget?
Do we need to allocate more funds to an individual expense, food, or utilities?
Can we use more towards our debt?
What can we do to increase our income?
Have you started saving for retirement? When do you want to retire?
Can we put money aside for our emergency fund?
The steps we have taken thus far will allow us to take control of our finances. Whether we would like to create a savings goal, put more resources towards knocking our debt or live frugally. Being able to track our budget will assist us in any of our financial goals.