If you want to manage your money better, one of the first things that you’re going to have to learn is how to create a budget.
It is easy to go through life spending money without a budget. It makes you feel rich and carefree. Unfortunately, the reality sets in when you do not have enough money to pay important bills.
Some people begin budgeting when they are very young while others will not start until they are far into adulthood.
It doesn’t matter when you begin budgeting as long as you do it as soon as possible. You are never too old to learn how to budget.
What is a Budget?
A budget is basically a comparison of your expenses and your income and a description of how much money from the income goes into each expense.
A very simple budget might be an income of $1000 per month in a budget of $500 for rent, $200 for food, $100 for clothing, $100 for entertainment and $100 in emergency savings.
Of course, budgets are much more complex than that, but for someone living in home and receiving $1000 per month that might be a realistic budget.
We are going to take a look at much more complex budgets that factor in both variable and fixed expenses as well as spending priorities.
There are a number of apps and online services you can use to help you create a budget. One we have covered is called Personal Capital.
It’s a free app with a lot of features such as wealth tracking, budgeting, net worth calculator and so on. It will help you get a clearer picture of your finances.
Read our full review here.
The Components of a Budget
There are several different components of a budget you should be aware of. We are going to look at a few of them below. Understanding the parts of the budget will allow you to understand how to use a budget better and become more effective in managing your money.
The first part of your budget will be your income. Income is different for everyone. Not only do people get paid on different days in different frequencies, but everyone makes a different amount of money.
Some people get paid every week, some people get paid twice per month and others have jobs where they get paid when they finish a project which could be every couple of days or so. Some companies pay monthly, but there rare because most people prefer to have a paycheck coming more often than once per month.
In the first part of your budget, you will list how much you have coming in from your job or other income and when you will be receiving it.
Ideally, you could use the previous month’s paychecks to pay next month’s bills so that you have exact figures when it comes to how much you will make. But this is not always possible
Your fixed expenses are expenses that are the same amount each time. Your cell phone bill might be an example. It is also likely that you pay the same amount of rent each and every month.
These are your fixed expenses. Fixed expenses are nice because you always know what you are expected to pay. This makes it very easy for you to budget for them. In fact, you can predict down the road how much you might be able to save or something or whether you can buy something you have been wanting because you know those fixed expenses are going to be consistent no matter what.
Variable expenses, on the other hand, are expenses that change each month. They might change because they are based upon usage such as your electric bill or they might change because they are based upon some kind of payment plan that doesn’t have consistent payments.
Variable expenses also include expenses that are not necessarily bills but things that you need to buy such as groceries, clothing, gasoline or bus fare and various other expenses.
These are more difficult to predict, but one of the benefits of having a budget and tracking your expenses over a few months is the you have an average amount that these expenses usually come to.
When you are saving for something specific, it can be helpful to put it into your budget. For example, if you need repair work done on your vehicle soon, then setting aside a certain amount that you need to save in order to get the repair done before your car breaks down can be extremely helpful.
Generally, what you should do is determine what larger expenses you have coming up and then prioritizing them. Then you can make a plan for how much you can set aside. You can do one expense at a time or save for multiple things at once.
Whatever is left over should go toward your emergency savings. Emergency savings is money that is in your bank account specifically for emergencies.
They’re going to be times in your life when your income no longer exceeds your expenses for whatever reason.
You might’ve gotten sick and had some unpaid leave from work, you might’ve gotten laid off for a period of time or you might have had to take care of a major medical bill that left you with very little money to pay your bills with.
Whatever the reason, emergency savings is there as a cushion in case of something going wrong. Setting aside whatever is left after you pay your bills is a great system.
Prioritizing Your Budget
You also need to prioritize your budget. There are several things to keep in mind when it comes to prioritizing your budget, but if you do not take this step, then you are going to be paying bills in a random order that may cause you problems down the road. Let’s take a look at what you need to know to prioritize.
Absolute expenses are expenses that have to be paid right away and that will have consequences if they are not. For example, if your rent is due on the first of the month and you have to pay a late fee of $25 per day that you are late, then your rent is probably at the top of your absolute expenses.
Not only does your budget start on the first of the month, but your rent is due that day is well. That means it should be the first thing that you take care of.
Look at all of your various expenses and categorize the ones that are due right away or will have consequences for paying late as absolute expenses.
If your bills are due later on in the month or you can pay them at any time during the month, then they are what are called flexible expenses.
Flexible expenses do not have to be paid right away. If you get paid every two weeks, and use your second paycheck to cover some of your budget, then you might wait to pay these flexible expenses until your second paycheck of the month arrives.
Flexible expenses might be your credit card bill arriving on the first but not being due until the 25th. Flexible expenses might also be grocery expenses because you know that you have enough food in the cupboard to last at least a couple of weeks.
You also want to categorize unnecessary expenses. Unnecessary expenses are expenses that you don’t have to pay it all. For example, if you have $200 a month budgeted for entertainment costs, it is not going to be the end of the world if you have to reduce that down to $100 per month.
Some expenses you may be able to get rid of altogether in the case of an emergency. This might include the money the you have been putting towards a new computer.
While you don’t want to skip these savings payments if you can help it, when a bona fide emergency comes along these expenses may have to go.
You might also notice certain spending trends that you can use for the future. For example, if you track your budget over a period of months or a year or even, you might notice that you buy clothing more during certain times of the year.
You may be doing this because that is when the big sales happen. If that’s the case, you can budget less money during other times of the year and budget more for when clothing goes on sale. Charts and graphs can give you a lot more information about your spending habits.
Projecting Your Budget for the Future
You can also use a budget to project and predict the future. You may be wondering what will happen financially in the future, in a budget can help you determine.
In the future, it is likely that your expenses are going to increase. For example, you may move from an apartment into a house and have a mortgage instead of a rent payment as well as the responsibility of bills like water and sewer that may have been included in your rent before.
Your grocery, clothing in many other categories in your budget may go up if you decide to have a child. If that’s the case, your entertainment budget will also likely go down. There will be many changes to your expenses, and having a budget can help you deal with them when they come.
Major Purchase Savings
You should also use your budget to look at major purchase savings. For example, you may be able to look at the next couple of years if you have enough past data in order to determine how long it will take you to save up for a down payment on a house.
Saving up for major purchases can be unpredictable, but having a budget, and having kept track of your budget for the past few years, can give you some vital information that will help you plan for the future and meet your financial goals.
Whether you are buying a new car, saving up to put a down payment on a house or planning some other major financial purchase, there is no doubt that a budget can help you look at the future with clearer vision.
The bottom line is that your budget is one of the best tools you have to manage your money better. However, if you’ve never used a budget before, it can be pretty intimidating.
But now the you know what fixed expenses are, what variable expenses are and how to arrange your budget, you have a much better understanding of how to work with one successfully.
As for the medium that you use, there are a lot of options out there. Many people prefer to use a simple spreadsheet.
You can put formulas in, color-code everything and customize exactly the way you want. There are also templates out there that will give you a basis with which to start.
There are also budgeting apps for your smart phone or mobile device the range from free to fairly expensive and from really great too horrible.
You want to decide which technology you want to implement to do your budget. It may take some research and some trial and error to figure out which method works best for you.