The 6 steps to an effective budget
Research shows that the #1 cause of stress at home is money; however, the majority of people don’t have a formalized budget or financial plan. A budget is an integral part of achieving your financial goals and can help you to find financial clarity. Take these steps to help prioritize your spending and manage your cash flow.
- 1) Determine all income – Add up all sources of income that you anticipate from all sources you reasonably expect to receive. Include salary, bonuses, tips and other dependable sources of income; items such as gambling winnings and gifts should not be included. Make sure to use after tax as well as any employer sponsored program dollars such as health care and retirement, to determine a true disposable income.
- 2) Determine all expenses – Gather all bills, credit card and bank statements to help you calculate your expenses for the month. Some of these will be fixed and some will vary. Take a 3 month average for variable expenses. Don’t forget to include periodic and annual expenses such as property taxes, insurance and gym memberships. Divide them by 12 for a monthly allocation to that expense.
- 3) Define Essential and Nonessential Expenses – Review your list of expenses and determine which are necessities and which are luxuries. It’s important to be honest with yourself when categorizing your expenses. For some people a gym membership will be a necessity and for others it will be a luxury. Nonessential expenses/luxuries will be your controlled variable if you need to increase savings or fund a financial goal. A lot of people don’t realize that $4 a day at your favorite coffee shop adds up to $1,460 a year. That can fund a nice vacation or one of your other essential expenses.
- 4) Positive or Negative? – Subtract all of your expenses from your disposable income. Hopefully the remainder is a positive number; if not, the budget will help you to get back on track.
- 5) Adjust to desired outcome – Your results will lead you to one of two conclusions. If your expenses are greater than your disposable income, you will want to look at your nonessential expenses to determine where you can make realistic cuts. You can take a small percentage from all, or cut one to align your budget with the desired goal. If your disposable income is greater than expenses, you can set and fund financial goals. If you haven’t already established an emergency account, put aside 6-12 months of expenses in case an emergency occurs. Subsequently, you can increase contributions to retirement accounts, investments, or fund another financial goal that is important to you.
- 6) Stick to it! – It’s important to stay at it. Don’t be discouraged if you’re over budget one month. Your budget should be flexible and a tool to help you achieve financial success, not viewed as a hindrance from enjoying everyday life. Try this link for a sample budget worksheet to get started.