Step 1: Net Income
The first step is to identify the amount of money you have coming in. It’s easy to overestimate what you can afford if you think your total salary as what you have to spend. Remember deductions for Social Security, taxes, 401(k) and flexible spending accounts. Your final take-home pay is called net income, and that is the number you should use when creating a budget.
Tip: If you have a hobby or a talent, find a way to supplement your income. An extra source of income can also be helpful if you lose your job.
Step 2: Track Spending
Track and categorize your spending so you know where you can make adjustments. This will help you see where you are spending the most money and where it might be easiest to cut back. List all fixed expenses (rent/mortgage, utilities, car payment, etc).
Next list all variable expenses, such as groceries, gas, and entertainment. This is where you might find opportunities to cut back. Credit card and bank statements are a great place to find itemized or categorized expenditures.
Tip: Record daily spending with anything handy.
Step 3: Goal Setting
Make a list of all financial goals you want to accomplish in the short- and long-term. Short-term goals should take no longer than a year to achieve. Long-term goals, such as saving for retirement or your children’s education, may take years to reach. Remember, goals don’t have to be set in stone, but identifying priorities will help set a budget.
Step 4: Make A Plan
Use both variable and fixed expenses to compile a sense of what you’ll spend in the coming months. You can predict fairly accurately how much money you’ll have after fixed expenses. Also, use your past spending habits as a guide when trying to predict your variable expenses.
You can break down expenses further by things you need to have and things you would like to have. For example, gasoline to drive to work every day would be considered a need. A monthly subscription to Spotify or Netflix, however, might count as a want. This difference becomes important when trying to make adjustments.
Step 5: Adjust Habits
Now that you’ve completed the first four steps you can complete your budget. You can start to see where money is left over or where you can cut back to put money towards your goals. Skip movie night in favor of a movie at home. You need the internet at home, but do you need the fastest? Adjust your wants and see how much money that frees up.
Lastly, if the numbers still aren’t getting to where you’d like, you can adjust fixed expenses. It will be more difficult, but on close inspection, a “need” may just be “hard to part with.”
Tip: Small savings can add up to a lot of money, so don’t overlook the little stuff. You might be surprized how much many can be saved with just minor adjustments.
Step 6: Check In
Review your budget on a regular basis to be sure you are staying on the right track. Few elements of a budget are set in stone: You might get a raise, your expenses may increase or maybe you reached a goal and want to plan for a new one. Whatever the reason, keep checking in on your budget and continue to follow the steps above.