Most people’s incomes are limited. So with this limited income they have to meet all the expenses. So to cover all expenses with a certain amount of income they need to know “how to make a budget”.
If you have a clear idea about “how to make a budget” then you can control your spending and work toward your financial goals.
If you can create a budget in the right way then you are less likely to fall into financial crisis in the future. You can safely spend money and increase savings.
What is personal budget?
A Personal budget or household budget is a systematic plan of how much will be spent from future income, how much will be saved and how much portion will be used in loan payment.
However, when creating a personal budget, you need to consider future expenses and debts as well as past outlays and loans. Because if in the past you spent more than you earned and became indebted, then in the future you will have to reduce the amount of expenses.
How to make a budget?
To create a perfect budget you have to follow some steps. Such as
- Pile up your financial Documents
- Determine your monthly income
- List monthly expenses
- Follow the budgeting plan
- Trace the progress of your budget
- Review your budget and make adjustments if needed
Pile up your financial Documents
To create a budget, you first need to gather information about your income and expenses. Financial Documents are the main source to get details about revenue and expenditure.
Financial Documents will be especially helpful in creating a budget. Because it records all your earnings, bills, investments, etc. information. Therefore, you have to keep these documents very carefully. If you lose a document, you will not be able to create a budget properly.
- Bank statements
- Investment accounts
- Wages and tax statement (W-2 and/ or 1099)
- Credit card bills
- Latest utility bills
- Auto loan/ Home loan statements
- Receipts from the last three months
- Last three months pay slip
Determine your monthly income
How much do you earn per month? You may say $5,000. But this is total income. To create a successful personal budget you have to figure out net income.
To find out the net income, deduct the income taxes, various types of utility bills, insurance premiums or retirement saving contributions from the net income.
After deducting these expenses, you can make your budget based on the money you have left. Your financial goal will be to spend less than your net income.
Many people make money by doing other work as a side hustle besides day job. Such as – make money from blogging or YouTube, make money through freelancing, make money from online or offline, income by investing in stocks, etc. You may add these incomes to the budget. And there is no need if you do not want. Extra income will help you meet your budget deficit.
List monthly expenses
After determining the net income, you have to make a list of all your expenses. For this you can analyze the expenses of last three or six months.
There are two types of expenses. 1. Fixed expenses 2. Variable expenses.
Fixed expenses include:
- House Rent
- Mortgage payments
- Loan payments (such as student loan, auto loan and personal loan)
- Insurance premiums
- Cable TV/Internet
Variable expenses include:
- Car repairs
- Child care
- Entertainment cost
After listing the expenses, if you see any unnecessary expenditure in any sector, you should try to reduce it. A lot of money goes out of our pockets due to ignorance which we do not understand. I should say about credit card. We know that credit card interest rates are high, in spite of knowing this many of us make a lot of purchases with credit cards. But if we can reduce the use of credit card by purchasing with cash then we can save some money. You can easily reduce costs if you know how to save money.
Follow the budgeting plan
To make a successful budget you need to choose a budgeting plan.
The budgeting plan will help in the implementation of the budget. You have to move forward according to that plan.
You need to plan the budget according to your needs. If you want to increase savings, you have to pay attention to that and if you want to reduce costs, you have to come up with cost reduction strategies.
Budgeting plan examples include –
- Envelope system
- Zero-based budget
- The 50-20-30 Budget
These will be discussed in the next section.
Trace the progress of your budget
After creating the budget, it has to be monitored every month. You have to notice whether the expenditure is less than the income per month. If the cost is less than the revenue, then it is understood that you are on the right track. And if you see that the expenses are more than the income, then you have to realize that you have a problem in making a budget.
You can follow a strategy to solve this problem. When you see that there are several days left in the month but you are moving closer to the spending limit, reduce the amount of spending in different categories.
One of the purposes of budgeting is to save money by reducing costs each month. Try to increase the amount of savings every month. Suppose you earn $5,000 a month. The goal for the first month is to save $300 after spending $4,700. Next month goal will be to save $400. This way, if you can save some money every month, you can assume that your budget has been successful.
Review your budget and make adjustments if needed
Budgeting is an ongoing process. It should be reviewed from time to time. In the future, the situation may not be favorable for any reason. As an example, i can mention COVID-19 pandemic. COVID-19 has wreaked havoc on the world economy. People’s income has decreased. But before the epidemic began, did anyone ever think that the world economy would be in such a bad shape?
Therefore, considering the situation, the budget plan has to be changed. Because changing circumstances can change your needs. In the future, you may lose your job, and the expenditures of your family may increase due to the arrival of a new member in your family.
Again, it may be that you are earning a decent amount by investing in stocks as well as day jobs. If you have a excellent idea about the investment strategy, you can make a good amount of money by investing a small amount of money.
There is no need to change the budget if you see your income increasing. The budget needs to be amended if you notice that your expenses are higher than your income due to special circumstances.
What is the Envelope System?
Photo – lifehacker
The Envelope System is a method where a person divides his total income into different categories of expenses. This concept is a traditional concept. This is very useful for those who prefer to shop directly without using online.
This method is very simple. Take a few envelopes, write the cost category on top of each. Such as – groceries, rent, medicine / pharmacy, utilities bill, car maintenance, entertainment, gifts. Then put the amount of money you will spend in each category in the envelope.
Then at the end of the month you have to calculate how much you spend and how much you save. One of the advantages of this method is that since all the revenue is distributed in advance, there is no chance to spend more. If more money is spent in one category then you have to take money from another category. So you must be careful not to spend more than a certain limit.
What is zero-based budgeting?
If anyone wants to spend every month in such a way that at the end of the month his balance is zero then he can follow zero-based budgeting. Zero-based budgeting is a method where a person’s entire income is spent on his or her expenses. This means that he spends the same amount of money as he make per month and if the expenses are deducted from the revenue at the end of the month, the balance becomes zero.
Photo – vertex42
Zero-based budgeting starts from zero base. At the beginning of each month, the budget has to be analyzed to keep pace with need and expenditure. The size of the budget may vary depending on the results of the previous month and current expectations. You can allocate the same amount in each category if you want and again you can allocate some amount more due to inflation.
Because of its detail-oriented nature, the zero-based budgeting process will continue year after year and will be reviewed from time to time. We have to prepare the budget for the next month by learning from the previous budget. You have to ensure that the amount spent is not in any way higher than the income.
What is the 50-20-30 Budget?
The 50-30-20 rule was originated in 2005 from Elizabeth Warren’s book “All Your Worth: The Ultimate Lifetime Money Plan”.
The 50-20-30 rule is a simple and sustainable budget technique. So people like this technique. The basic rule of thumb is to allocate a person’s after-tax income into three categories – 50% for needs, 30% for wants, and 20% for savings, or paying off debt.
It is a smart and straightforward monthly budgeting method. This way you can easily find out how much money you are spending per month and how much money you are saving per month. This allows you to avoid overspending and increase the amount of savings.
How does the 50-30-20 rule work?
According to this budget rule, you will first divide your income into three categories – needs, wants, and savings or debts.
There are some necessities that you can’t ignore. Spend 50% of your after-tax income to meet those needs.
- Electricity and gas bills
- Insurance premiums
- Monthly loan repayments
The next 30% of your after-tax income will be used in the category that you do not really need but you want to spend in order to live a comfortable life. Wants are the non-essentials expenditures.
- Restaurant meals
- Clothes shopping
You spend 50% of your after-tax income on basic needs, 30% on wants, then you can use the remaining 20% to achieve savings goals or repay additional debts. If you can save 20% per month, you can use that fund for other purposes, such as creating an emergency fund or implementing a long-term financial plan.