12 Steps for How to Make a Budget – Personal Budgeting Tips for First Timers
Creating your first budget can be extremely overwhelming. So overwhelming, in fact, that only 40% of American families have a working monthly budget. But it’s worth the effort. Developing a budget that you can maintain over the long term has been definitively linked to building wealth, while simultaneously helping you get out of debt and cut expenses.
When I built my first budget several years ago, I knew approximately how much money I was making annually, but I had never broken down my expenses by category to figure out what I could afford on a recurring basis, or how much money I could regularly invest.
In short, I was spending money on the things I needed and wanted without determining first whether I could truly afford them. After overdrawing my checking account once or twice, and having to pay several bills with credit cards because of my lack of a working budget, I decided to get real and begin a budget.
If you’re a first-time budgeter, here are 12 steps to make the process as smooth and painless as possible.
1. Decide to Start a Budget
If you are reading this article, chances are that you have already made the decision to begin a working budget. Congratulations! For many people, myself included, this is the hardest part. Read on to get started with next steps.
2. Know How Much You Have
If you have savings, checking accounts, investment accounts, or any other financial instruments, you will want to know how much money is in each account as well as the interest rates and expenses of each one. Make note of this information as it will become important in determining your net worth and the best use of your capital in the future.
3. Know How Much You Make
For some people, this is easier than others. Those on a salaried pay scale can easily find their monthly income. For hourly employees or those who work in a business where income may rise and fall unpredictably, this can be much more difficult. The most important consideration, regardless of how you earn your monthly income, is to determine the average monthly amount of income that you receive. A good way to do this, if you receive irregular income, is to average out the last 6 to 12 months of recurring income and use that figure. If you want to be extra conservative, you can choose the lowest monthly amount you have earned in the last year, which will hopefully provide you with a worst case scenario.
4. Know What You Owe
Determining your monthly recurring debt payments should be your next step. This should be fairly simple to do, as long as you have stopped incurring additional debt in the short term. If you haven’t been able to break your dependence on credit cards, that’s okay, as building a budget will act as a first step for your next financial priority which should be getting out of high interest consumer debt.
To find out what your monthly recurring debt payments are, calculate the total amount owed on each debt account as well as the minimum monthly payment. This includes car loans, mortgages, credit card debt, student loans, and all other debt that your family pays on a monthly basis.
This will provide you with the first few line items in your budget, and will allow you to determine your net worth.
5. Determine Your Net Worth
Once you know how much money you have and how much you owe, you can easily determine your net worth. Just subtract what you owe from what you have, and you will derive a number. This number will tell you the value of your financial resources. For me, this number was an eye opener. When I built my first budget, I had a negative net worth. I assume this is fairly common in America, especially for young people just starting out.
6. Determine Your Average Recurring Monthly Expenses
This can be the hard part for many people. The best way to determine your monthly expenses is to make a stack of household expenses for a month. Keep your receipts, your utility bills, and any other expense that arises during a one month period, and divide these bills into categories. The categories can be as general or as specific as you want them to be. I keep my categories extremely general (automotive/household), whereas you may prefer specific itemized categories such as (car wash/electric bill). Either way works well, as long as you determine an average amount of expenses for each category.
7. Enter this Information into a Database
It used to be, if you had a budget, you had an old school paper ledger. Things have changed for the better for all of us new budgeters. Software programs like Microsoft Excel and online budgeting tools like Mint, You Need a Budget, and Mvelopes have made it much easier to take the results of your first few steps, and develop a highly adjustable and sustainable long term budget. I use Microsoft Excel for my own personal budget, because it allows a greater deal of flexibility than sites like Mint. However, many people swear by online budgeting sites, and whichever path you choose will ultimately help you build greater wealth and greatly help keep you out of financial trouble.
8. Look at the Bottom Line
After entering all of the above information, you will discover the most important number in your budgeting process – the bottom line. This number will tell you whether you are overspending or underspending. Ideally, during this step you will find that you are living within your means, and maybe will even have a little left over on a monthly basis. On the flip side, you may determine you must make adjustments to your monthly expenses in order to live within your means.
9. Make Adjustments Accordingly
If the bottom line of your budget proved that you are overspending your monthly income, you will come to the most difficult step – making cuts to your monthly expenses. There are tons of resources here on Money Crashers that will teach you to be smarter with the income you have, help you cut your recurring monthly expenses, and establish your financial boundaries for personal budget planning.
10. Adjust Categories Based on Reality
Life is full of surprises. Food gets more expensive, gas prices rise, and rent can get hiked when you least expect it. Each time you notice inflation creeping up on your expense categories, get a raise at work and begin to earn more money, or worse, suffer a financial setback like a pay cut or job loss, you must adjust your categorical expenses based on the realities of the world around you.
11. Pay Yourself First
Depending where you are in your budget, based on your bottom line, you may want to add a few extra line items to your monthly expenses. These may be monthly dispersals to a savings account like Capital One 360 or Ally Bank, Roth IRA, 529 college savings plan, or other savings vehicle. Moving money into savings and treating it like a recurring expense will allow you to slowly build up your savings without feeling like you must make these deposits from what is left at the end of the month.
12. Track, Monitor, and Be Disciplined
Keeping track of your budget takes an hour or so a week. But this will save you a lot of time in the long run. Once you have an established budget, you will want to keep it in check. The discipline and associated knowledge that you are making good long term and short term financial choices will provide you with a great deal of comfort, and will take you from living paycheck to paycheck to being able to see the long term results of your disciplined savings and financial planning.
If you don’t have a budget, now’s the time to create one. By following the above 12 easy steps, you’ll be on your way to financial freedom and building wealth for the future.
Do you have a solid personal budget in place? What has and hasn’t worked for you? Share your best personal budgeting tips in the comments below.
Pat S is an active duty military officer. On his off time he enjoys working out, reading, writing and spending time with his dog. Pat became interested in personal finance after several costly mistakes early in his military career that could have been avoided by a basic understanding of personal finance.
12 Steps for How to Make a Budget – Personal Budgeting Tips for First Timers
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