What is a budget and why do you need one?
A budget, much like in accounting, is a simple way of determining whether your spending habits are causing you a profit or a loss. The budget is all about the bottom line and the truth it’s trying to bestow upon you. Ask any wealthy person what they spend on food last month and they will come back with a number. Ask any poor person and be prepared to hear of lot of “I’m not sure..”. Why is that?
“A budget is telling your money where to go instead of wondering where it went.” – Dave Ramsey
One of the fundamental steps to developing your financial literacy is creating your own, personal budget. It is by far the best and most effective way to take control of your finances and showcases if you are living within your means.
Most people walk through life blind about where their money is going, having no means of tracking their wallet. How can you know how much you need to save for something when you don’t know how much you need to spend to stay alive? How do you know if you can afford to take out a mortgage, go on a trip, buy a new pair of shoes? That, my friends, is where the bottom line comes in with the answer.
The 5 Steps to Easy Budgeting
The good news is that making a budget is relatively easy, with free resources galore such as the MoneySmart Budget planner. Or if you’re old fashioned like me, you can create your own budget in Excel or by taking pen to paper with these 5 easy steps. For thepurpose of this example, we used a monthly budget for personal expenses, however you can pick your own timeline for your budget if you prefer.
- First, gather up all your sources of income.
All the money that has crossed your hand for the past 30 days, cash or credit card, should be recorded. This includes your salary, tips, any side income from divides, bonds, interest, stocks, rent income or that pet-sitting gig you sometimes do for your neighbour. Leave no dollar uncounted!Added together, these streams of income should give one magic number, rounded to the nearest whole number. This will be labelled as income.
- The second step is to gather up all of your expenses.
This includes EVERYTHING you have spent money on in the last 30 days. This is the hardest part of the process as it can often be challenging to track your expenses, especially by cash. Try to recall as best you can from memory, receipts and bank statement what you have spent on. This includes food, clothes, gas, bills, movie tickets, cat food etc. Yes, the coffee you bought with the spare change in your pocket too.Be brutally honest with yourself and don’t discount “one-off” purchases. As with the step above, you should get another magic number rounded to the nearest whole number. This will be labelled as expenses.TIP: It is very difficult to track cash purchases, hence why it’s recommended you use card (debit if you can) to pay for things as they are easier to trace.
- Now that you have both your income and your expenses, the next step is simply to deduct Income from Expenses and see what the bottom line tells you.If your number is positive, congratulations, you have been living within your means. If your number is negative, the news is not too great.
If you have been living above your means or just within your means with very little leftover, it is time to get serious about budgeting and take control of your spending habits.What did your number tell you? Pause and reflect about this before moving onto the next step.
- Learn the difference between a necessity and a luxury.
Remember all those expenses we listed in step 2? Now it is time to split them up into two categories; Necessities and Luxuries.Your necessities should include the sum of every dollar you have spent on food, shelter (rent), bills (such as gas and water). In other words, actual necessities that you need to stay alive.
Luxuries should include everything you’ve spent on clothes you didn’t need, alcohol, eating out, entertainment, bills such as Netflix and a magazine subscription etc. In other words, a luxury is everything you could’ve easily survived without this past month. Again, be very honest with yourself. I too am guilty of just ‘needing’ that extra leather jacket.The numbers should again tell you a story. Have you been spending more on luxuries than on necessities? Have you been spending on silly things you could’ve done without?
- Set a goal for next month’s budget and stick to it.
Set an ideal goal for what you would like your budget to look like for next month. Plan out your budget for next month and stick it on top of your fridge so that you are reminded of your goal every day.If you want to reduce your expenses, cut out some of your luxuries. If you like your luxuries, cut out some of your necessities eg. Walk home instead of driving.
Keep your budget in mind every time you reach for your wallet.
The following month, repeat the 5 steps and see if you’ve kept true to your goal.
Repeat this process until it becomes a habit and watch it slowly transform your life. And remember, “It’s not your salary that makes you rich, it’s your spending habits.” – Charles Jaffe.