This is a quick post regarding specific strategies to building a budget. I think it is important to note that a budget is tailored to each individuals situation and can change over time. Budgeting today will not only assist you with you current financial situation, but will also help to set you up for long-term success. Having a detailed budget makes it easy to see where every dollar you earn goes and may give you a new perspective or realization on your current spending habits. There are loads of ways to make a budget and the ones listed here are only a small list of my personal favorites. So, let's jump right in to our budgeting techniques:
Disclaimer: This is meant to be an informational guide, nothing in this post should be interpreted as individualized advice.
- Fixed vs. Variable: One of the easiest ways to construct a quick budget is to separate expenses by fixed and variable. Now, different sources will have different definitions for fixed and variable expenses. In this case, a fixed expense is something that has a consistently defined amount that does not fluctuate much or at all. An example could be rent, mortgage payment, car payment, child support, etc. A variable expense is something that can and does fluctuate based on the amount you use. This could be utilities, entertainment, gas, food, etc. It often helps to go through your bank statements to see how much you actually spend on what. This also helps you to remember the extra $10 to Netflix and other miscellaneous things you easily overlook. Once you have all your expenses tallied, subtract them from your after-tax (take home) income. At this point you look at how much is left over at the end of the month, and if necessary make changes where you think they can be made. Don't make the mistake of making a drastic change like cutting out all entertainment or buying half of the groceries you normally do. Every change to the budget has to be realistic and attainable. An example would be carpooling to save gas or going out to dinner once a week instead of twice. There is no point in making an imaginary budget that you could never follow.
- Categorize expenses: This option is a little more in depth than the previous, but helps to show exactly what categories are taking up the most money. To begin, break up expenses into categories such as debt payments, living expenses, insurance, etc. Make a note whether each expense is non-discretionary or discretionary (required to be paid or not). Once you organize all the expenses, you can take the same approach as before by subtracting from your after-tax income. When making adjustments, you usually start with items that you listed as discretionary.
- The income & expense statement: The most involved and hands down my personal favorite. This takes more of a big-picture approach to budgeting and allows you to look at total inflows and outflows for the year. This is often done in a two-part process by first completing the categorized budget (not required, but definitely helpful). You start by listing out and totaling your pre-tax income from each individual source. Then, follow with any pre-tax retirement contributions. Once you have done that, you may incorporate the individual taxes (federal, state/sales, FICA, property). From there you continue with the categorized expenses until you have your total cash outflows. For your convenience, I will give an example of what one may look like below:
Cash Inflows:
Income 1
Income 2
Total Cash Inflows
Cash Outflows:
Pre-tax contributions:
401k
Traditional IRA
Total Pre-tax Contributions
Taxes:
Federal income tax 1
State income tax 1
FICA Tax 1
Federal Income tax 2
State income tax 2
FICA Tax 2
Total Taxes
Debt Payments:
Car payment 1 (ND)
Car payment 2 (ND)
Student loan (ND)
Total Debt Payments
Living Expenses:
Food (ND)
Utilities (ND)
Gas (ND)
Vacations
Entertainment
Total Living Expenses
Insurance Payments:
Auto (ND)
Renters (ND)
Health (ND)
Life (ND)
Disability (ND)
Total Insurance Payments
Total Cash Outflows
Net Discretionary Cash Flows
You can see that I labeled each expense that was required (non-discretionary) to help identify where cuts could be made easiest if needed. You can create this on a monthly or annual basis depending upon how you'd like to look at it. The "net discretionary cash flows" section shows you how much should be left over at the end of each period, either monthly or annually. Keep in mind, this example was intended to show the layout for the income and expense statement, it is likely that yours will be much more detailed.
As always, I hope you've found the information in this post to be valuable. If you have any questions/comments, you are welcome to reach out to me directly at deanbarda@appleandassociates.com or (530) 272-1345.