Thursday, November 15, 2007

How To Create a Budget That Actually Works

This is a new series covering basic financial topics for beginners. I'll post a 'how to' like this one from time to time.

This is my take on how to create a budget. I'm not a financial expert, but I went through this process recently and it's had nothing but positive effects on my life, so I want to share my thoughts with you.

Some general notes:
  • I'm a single gal, so I don't have any experience doing this with a spouse or partner, but many of the concepts are the same. Just follow the steps together and work through your differences without fighting. Yeah, probably easier said than done, but I'm a single gal so what do I know?
  • I recommend using Excel or a similar spreadsheet program. It offers immense flexibility to create something that makes sense for each individual person.
  • Feedback is much appreciated. I'd love to hear how you implemented this, how it worked for you, and if you have any tips for improving the system.

Preparing to Budget

1. Take a deep breath. It's not as bad as you think, I swear. If I can do this, you can too. In fact, I actually think it's fun, so you can too.

2. Be brutally honest. No budget will work if you aren't honest about what you put into it. Do not lie to yourself (or anyone else) during this process.

3. Accept that your budget will be wrong. Don't worry, this is what will make it incredibly useful. Your life is never the same from month to month, so your budget won't be either, and whenever your budget is wrong, you can fix it to make it right. Your budget will be as flexible as your life.

Create a Template

1. Write down every source of income you have and assign an approximate dollar amount to each one. Even if your income varies a little, write down the average amount.

2. Write down everything you spend money on. This will probably take a few days to complete as you think of things to add to the list. Be sure to include irregular things like car registration, gifts, and travel. It can help to look around your home to jar your memory.

3. Assign a dollar amount to each expense. Use a new column to note this info. Some will be easy, such as rent or a car payment. Others could be more difficult to approximate like groceries or clothing. When in doubt, assign more than you think you'll need, and remember that you can always adjust things later.

4. Assign due dates. In another column, note the due date for each recurring bill. This will serve as an excellent reminder to keep you from paying any late fees.

5. Find a common denominator. You've probably got several units of time in your list: Monthly bills, bi-weekly income, yearly expenses, etc. Re-write all of the amounts into their monthly costs.
  • For yearly expenses such as car registration or property taxes, do not divide by 12. Instead, divide by the number of months between now and the next time that bill is due. Example: if your car registration is due in 6 months, divide by 6; if you divided by 12, you'd only have half the amount you needed when it came time to pay.
  • If you're paid bi-weekly, use the total amount of two checks to get your monthly income. You'll have two months a year when you get three checks, but you can treat the extra check as a windfall.
6. Categorize. Take a look at all of your expenses and sort them into categories. There are several methods you can use for this. I sorted them by type, i.e. Housing, Transportation, Entertainment, etc. You can also sort them into Fixed and Variable, or Necessities and Non-Necessities. Do whatever feels natural to you.

7. Do the math. Add up your income. Add up your expenses. Subtract your expenses from your income. The SUM formula in Excel is fantastic for this, and it's especially helpful as you adjust.

8. Adjust. If you have a negative balance after doing the math, you'll need to adjust or you'll go further into debt. If you have a positive balance after doing the math, you can to adjust to get the most out of your money. Take a look at everything you've allocated money for, and see if there are ways you can save that won't be painful.
  • Are you paying for things you don't use, like a land line phone, a gym membership, or cable tv? Cut them out.
  • Are you paying interest to anyone? Call your credit card company and get them to lower your interest rate. Consolidate your student loans to a lower fixed rate. Refinance your home at a lower fixed rate. Caution: Be sure to do your own research before doing any of these things; they aren't the best options for everyone.
  • Can you get the same product for cheaper somewhere else? Shop around for insurance and internet access to get the best price.
9. Adjust again. If you started with a negative balance, keep adjusting until you get to a zero balance. You may need to start cutting some more painful things, but make sure that you keep the necessities first, and the non-essentials that make you happiest second. Beyond that, cut away non-essentials that don't enrich your life as much. If you started with a positive balance allocate the balance to savings, debt repayment, or investments.

10. Save your work. This is your template to come back to time and time again. You can always adjust the template in the future, but keep it general so you can start there to create a budget for each specific month.

Make It Useful

1. Create this month's sheet. Right click on the sheet tab and create a copy of it. This will be your budget for the month you're in right now.

2. Get exact figures. In the new tab, start at the top and work your way down, changing each amount to the amount for this specific month. Your phone bill averages $40.00, but this month it's $37.41? Your income averages $2,000, but this month it's $2,013.49? Change the amounts to reflect the current month.

3. Adjust. After putting in your exact figures, your balance is probably not zero anymore. Readjust some of your categories to get back to a zero balance. Make sure you know where every dollar is going before it comes in.

4. Live life. This is the fun part. Spend your money! Pay your bills! And do it with the confidence that comes with knowing you have enough to cover everything.

5. Adjust. Yes again. You'll do this a lot, especially in the first couple months. As the month goes on, stuff will come up. You'll have to buy something you weren't counting on because life happens and you have to go with the flow. Your budget will flow with it too. When an unexpected expense comes up, put it in your budget and then take that amount from another category that can afford to be a little smaller.

6. Use discipline. Don't fritter away your balance. Lattes, DVDs, and video games are not unexpected expenses that you can spend your savings or debt repayment budget on. If you want those things, that's completely fine. It's up to you what you spend your money on as long as you budget it in to start with.

7. Repeat. Next month, copy the template to create a new sheet for that month and start all over. Each month is more practice, and practice will make perfect. Eventually you'll be a pro, I promise.

As you go through these steps, remember one very important thing: You can have anything you want. You just can't have everything you want. This mantra has made budgeting so much easier for me because I know that if I truly want something, I can have it. Money is only the tool we use to live life; it shouldn't drag us away from things that really fulfill us.


faisal said...

oh! great effort being done by you
keep it up and try to be more technical rather then general
i have also created a blog please do visit it

Matt and Carol said...

awesome girl!!!

Prathap said...

There are lot of free templates out there which has all categories that u can think of.
Link ::

I use the "Personal Monthly Budget" template listed there. Have customized such that One excel sheet has 12 worksheets for each month and one "home sheet" which lists total expenses, savings, purchases etc.

It is a neat idea as after few months u know how much u will be spending for each category and where u can cut for savings.

PRathap M