Why & How To Create A Budget: Beginner’s Guide
If you & your family want to lead a financially secure life, then following a budget is the only answer.
Literally!
What is a budget?
A budget is simply a spending plan that takes into account both current and future income as well as expenses. It’s an estimate of how much money you’ll make and spend over a certain period, such as a month or year.
4 Reasons To Create A Budget
1. It Helps You Achieve your Goals
A budget ensures that you always have enough money to achieve your short-term & long-term goals. It helps you save money to make your dreams a reality.
So if you really want to achieve your goals, living by a budget is a must.
2. It Sheds Light on Bad Spending Habits
Budgeting is not just about creating a spending plan but also taking a closer look at your spending at the end of the month/year. You may notice that you’re spending less money on your goals and more money on things you don’t need.
Budgeting will help you rethink your spending habits and refocus on your goals.
This brings me to the 3rd reason for having a budget.
3. It Ensures You Don’t Spend Money You Don’t Have
Almost everything in life costs money, but when you spend more money than what you actually make is when it becomes a problem
Most people who end up spending more money than they have is because they do not keep track of what’s going on in their bank accounts.
A Budget helps you solve that
4. It Prepares You for Emergencies
If there’s one thing that Covid has taught me more than anything else, it’s to be always prepared for emergencies.
When you get laid off, become sick/injured, or have a death in the family, it can lead to some serious financial loss.
That’s why your budget should include an emergency fund that consists of at least six months worth of living expenses. This extra money will ensure that you don’t get into a debt trap after a life crisis.
Now that you know how important living on a budget really is, let’s see how you should create a budget!
How To Budget In 6 Simple Steps
1. Set Goals
Write down what you want to achieve in the short & long term. Be as specific as you can be.
For example: If you want to take an International vacation with friends, mention whether it’ll be a week or month-long trip or whether will you be staying in hostels or 5-star hotels.
Being this specific will help you estimate your expenses and save accordingly.
These can be:
- Building an emergency fund
- Saving to buy a car
- Saving to buy a house
- Maximize your retirement fund
2. Calculate NET Income
If you are a salaried employee, then this part will be very simple for you. You’ll just need to write how much you earn per paycheck.
However, if you work as a freelancer, have your own business, or rely on tips or commissions, your monthly income will be an average of the past three to six months
3. Calculate Expenses
Once you know how much money you have coming in, the next step is to figure out where it’s going. Track & categorize your expenses to take a closer look at your spending habits.
Put all your expenses into the three following categories:
- Fixed Expenses
- Variable Necessary Expenses
- Discretionary Expenses
Fixed Expenses
Start by listing your fixed expenses. Most people have a good sense of their fixed expenses. These can be:
- House Rent
- Mobile/WiFi Bills
- EMIs
- House Loan
Variable Necessary Expenses
Once you are done listing your fixed expenses, it’s now time to list your variable necessary expenses. These are variable but necessary expenses that can change from month to month.
These can be:
- Groceries
- Car Repair
- Credit Card Bills
- Medications
Discretionary Expenses
These are the expenditures that you want rather than need. These can be:
- Dining out
- Shopping
- Entertainment
Once you are done calculating all your expenses, now is the time to add “Goals Fund” to your expenses.
4. Add Goals Fund to Your Expenses
You won’t be able to meet your short & long-term goals with whatever is left after all your expenses. So you need to add your goals fund to your fixed expenses.
Remember the goals that you mentioned in the first step, figure out how much you will pay toward each one every month. If your goals have a deadline then divide the amount of money your goal will take by the number of months until the deadline to dictate your monthly savings amount.
5. Compare & Adjust
Compare your expenses to your income. If the expense number is lower than or equal to your income number, then your budget is balanced. In that case, you are ready to implement your budget.
However, if your expenses are higher than your income, then you need to adjust your spending.
It’s important that you focus on adjusting discretionary spending or variable spending (such as your grocery budget) before you reduce your savings for your financial goals.
Protecting your “Goals Fund” in the budget will help ensure you reach the important financial milestones that matter to you.
6. Implement & Review Regularly
Once you have a balanced budget, you’re ready to implement your budget.
Start spending and saving based on the budget you have created.
As you implement and track your budget, you’ll notice patterns over time. These will help you make changes as needed to your budget and figure out what is important to you.
