Step-by-Step Guide on How to Make a Budget
Learning about budgeting is not high on the to do list of most people. They know it’s a good idea to have a budget but somehow they don’t want to feel restricted. However, you’ll soon discover that being in control of your finances is the first step towards financial freedom.
The purpose of having a budget isn’t to prevent you from enjoying life’s little pleasures. It’s to help you manage your finances. And, the good news is that it’s easy to learn how to budget.
What’s the Definition of a Budget?
Budgeting is the process of finding a balance between incoming funds and outgoing funds. The tool used to manage this process is called a budget. It allows you to plan and allocate money in advance to essential items, non-essential items, and savings.
Why Budgeting Is Important
The average person has many expenses every month, ranging from needing to buy food to paying for a loan. It’s very difficult to keep track of all these expenses in your head. Trying to manually calculate if you have enough money left to last until your next paycheck isn’t easy.
But, it’s not only about the risk of running out of money and not being able to save or pay a bill. It’s also about making life easier for yourself. You don’t want to ask yourself every time you want to buy something if you can afford it.
By having a budget, and sticking to it, you can avoid a lot of unnecessary stress.
How to Make a Budget in 5 Easy Steps
Making a budget is all about creating a plan that will help you manage your finances.
Step 1. Determine your after-tax income.
After-tax income is the money you’ve got available to save / invest, or spend on the things you need or want. It’s your take-home pay.
For budgeting purposes your income includes interest and dividends received, investment income, and gifts / refunds. If you have savings you intend to use then add it to the list.
Step 2. Make a list of all your expenses.
Make a list of your typical monthly expenses.
Refer to any relevant documents that can help you, such as bank statements, credit card statements, and old bills. You also need to think about new, upcoming expenses that should be included in your budget.
Step 3. Separate your expenses into needs and wants.
Once you’ve made a list of all your expenses, separate it into needs and wants. Needs are essential items that you have to pay for. Wants are non-essential items that are nice to have.
Examples of needs include:
- Debt & Loan Payments – Includes mortgage, car loan, credit card, and any loans.
- Monthly Accounts Payable – Includes rent, utilities, school fees, and child support.
- Insurance – Includes car insurance, life insurance, and health insurance.
- Food, Clothes & Groceries – Includes household supplies, and pet food.
- Health – Includes medicine, and visits to the doctor or dentist.
- Transportation – Includes public transportation, gas for car, and car maintenance.
Examples of wants include:
- Entertainment & Leisure – Includes eating out, sports, hobbies, movies, and gym.
- Charity & Gifts – Includes religious and charitable donations.
- Luxuries – Includes brand name shoes and clothes, and jewelry.
Step 4. Add savings & investments.
If you don’t budget for savings and investments, chances are you’ll never have money left to save or invest.
Under savings you can include items such as retirement, and extra debt / loan payments. Your budget should include an emergency savings fund for unexpected emergencies that you didn’t budget for.
You can also include a special savings plan to save up for something you need or want.
Under investments you can include items like stocks, bonds, mutual funds, real estate, index funds, options, and precious metals. You don’t have to include all these items in your budget.
Step 5. Balance income and expenses.
After you subtract your expenses, including savings & investments, from your income the total should be zero. Your income and expenses should balance out.
Target = Zero balance – Your expenses, savings and investments are equal to your income.
Positive balance – You have money left in your budget.
Required action: Add the money you have left to savings or another budget item.
Negative balance – Your expenses exceed your income.
Required action: Cut back certain items until your income and expenses balance out.
By following the above steps, you’ll be able to create a fit for purpose personal budget.
It will take a while to complete when you do it for the first time. But, once your budget is in place it becomes easy to manage. You then only need to review and update it.
To give you a head start, download our budget template. It’s an easy to use Excel template. Feel free to change the item descriptions based on your unique circumstances.
Budget Plan vs Actual
Your budget spreadsheet should have a “budget” and an “actual” column.
A budget is a forecast. It’s what you’re planning to spend, save, or invest.
It contains expenses that are either fixed or variable.
Fixed expenses – Will normally remain unchanged month after month which makes it easy to budget for. A mortgage and car loan are examples of fixed expenses.
Viable expenses – Can change from month to month. The best way to budget for variable expenses is to look at how much you’ve spent the previous month. Food and groceries are examples of variable expenses.
Tip: Try to treat savings as a fixed “expense” by saving at least the same amount of money every month. It can be either a fixed amount in dollars, or a percentage of your income. Don’t wait until you’ve paid everything and only then try to save what’s left.
Every budget needs to show the actual amount of money spent, saved, or invested.
You need to be able to compare budgeted vs actual expenses. The difference between your budget and actual results is called a budget variance. By managing budget variances you’ll be able to plan better.
17 Benefits of Budgeting
- It encourages you to save – Many people make the mistake of only saving money if they have any money left at the end of the month. Other people simply forget to save because they are not reminded of it. By adding a savings plan to your budget, you’re able to budget for it in advance.
- Helps you differentiate between needs and wants – By having a budget you can differentiate between needs (essential items) and wants (non-essential items). This will help you find a balance between things that are important versus things that are nice to have.
- Deters impulse buying – Impulse buying is when you buy something on the spur of the moment without first thinking it through. Having a budget discourages this type of behavior that often leads to buyer’s remorse afterwards.
- Helps you plan ahead for unexpected emergencies – We all need money from time to time for unexpected emergencies. By adding an “emergency fund” to your budget you can save money every month for emergencies.
- Helps you plan how to get the things you really want – You don’t have to deny yourself a luxury item if you plan ahead and budget for it. By using a budget you can set aside money for it every month until you can afford it. Delayed gratification can be just as sweet as instant gratification, if not more.
- Gives you time to think about what you really want – Having to save up for certain items gives you time to think if you really want it. You may find that by the time you have the money for it you’d rather spend it on something else. Or, you may decide to save or invest the money instead.
- Monitor where your money goes – Ever wondered where all your money went or why it didn’t last very long? With a budget you can monitor your expenses. It can also reveal where you may be wasting money.
- Don’t get into trouble for forgetting to pay a bill – Having a budget can help you keep track of when bills are due for payment.
- Flexible money management – A budget isn’t cast in stone. It allows you to manage your money and gives you the flexibility to do so. You can increase or decrease the amounts you’ve allocated to certain budget items during the month, as necessary.
- Handy to have when you need money – Whether you want to apply for car finance or a mortgage, your budget can support your application. It shows how you manage your finances and how you’ll be able to make payments.
- Customizable to match your unique needs – It doesn’t matter if you’re a young married couple, single, or divorced with children. You can create a budget that’s right for you.
- Puts you in control of your finances – If you’re not in control of your finances you’re like a ship without an anchor. It can be very stressful. Having a budget allows you to take charge.
- Supports both short-term and long-term goals – A budget doesn’t only have to focus on a single month. It can and should also support your future goals.
- Gives an overview of how well you’re doing – A budget doesn’t only show how much you’ve spent on food this month. It also shows how much you’re making, saving, investing, and paying towards debt.
- Helps you reassess / reduce your expenses – A budget makes you reassess your expenses on a monthly basis. Not only for non-essential items but also for essential items. For example, it makes you think about questions, such as: “Can’t I get cheaper car insurance elsewhere?”
- Get “buy-in” from your family – Arguments about money are never pleasant. By having a budget discussion with those in your household you can all be on the same team.
- Helps you think twice about credit card debt – Swiping your credit card is easy. But, unless you can pay the balance in full every month it can quickly become a debt trap. If you have a budget it’s easier to resist just using your credit card to buy what you want.
Broke? Low Income?
Do you need a budget if you’re broke?
The short answer is that unless you have no income at all, you need a budget.
If you don’t have an income your first priority should be to find a way to make money. But, as soon as you’re making money, you should put a budget in place.
Most people that complain they are broke have an income. They just run out of money too soon. By having a budget, you’ll be able to identify where your money is going and how you can better manage it.
What if you have a low income?
It doesn’t matter if you have a low income, or feel you don’t earn enough to have a budget. It also doesn’t matter if you don’t have a stable income. As long as you have an income you need a budget.
Even if it’s a simple budget that only shows your income and some expenses, it’s still good to have one. As your financial situation changes you can adjust your budget accordingly.
The 50 30 20 Budget
The 50 30 20 budget is a budget plan from Senator Elizabeth Warren and her daughter Amelia Warren Tyagi, detailed in their book All Your Worth: The Ultimate Lifetime Money Plan.
It’s often referred to as the 50 30 20 rule and has gained a lot of popularity over the years.
Based on this budget plan, your after-tax income should be spent as follows:
50% on Must-Haves
30% on Wants
20% on Savings
According to the authors, “must-haves” are the things you need, and “wants” are stuff that’s just for fun.
For example, if your take-home pay is $5,000 then no more than $2,500 should go towards your needs. You can spend up to $1,500 on the things you want, and save $1,000.
What do I like about this budget plan?
It’s not complicated. It’s pretty easy to understand. But, what I like the most about it is that it proposes a balance between needs, wants, and savings.
There’s a proverb that says: “All work and no play makes Jack a dull boy.” In order to live a fulfilled life, you need a balance in your life. And, this balance also applies to your personal finances.
Life isn’t about only spending money on your essential needs, and saving what you have left. It’s also about enjoying life’s little pleasures.
Establishing a balance between your needs, wants, and savings is important. It has a direct impact on the quality of your life.
What don’t I like about this budget plan?
It’s too restrictive.
The 50 30 20 split, as proposed by Elizabeth Warren and her daughter, is more of a rule than a plan. According to them, you can only move away from it at “special times in life.”
This can create the impression that unless you stick to the 50 30 20 ratio there’s something wrong with your budget plan.
A budget needs to allow for more flexibility. One size doesn’t fit all.
For example, a divorced man earns $3,000 per month after tax. He has to pay 25% of his income ($750) towards child support. Based on the 50 30 20 rule he only has $750 left for his rent, car loan, student loan, insurance, food, etc. It’s simply not workable.
So even though he doesn’t have enough money for his essential needs, he should spend 30% on fun stuff and save 20%? It makes no sense. It’s not the right budget plan for him.
In his current circumstances a 70 15 15 ratio would be more appropriate. This will allow him 70% for needs, 15% for wants, and 15% for savings.
Creating a budget from scratch can be very time consuming. Fortunately there are budgeting tools you use to speed up the process.
Here’s a list of popular budget apps you can use.
Mint – One of the most popular budget apps. It’s free to sign up for an account, and easy to use.
Wally – A free personal finance app that helps you keep track of where your money goes. Compare your income to your expenses and set goals you’d like to achieve.
PocketGuard – A free app that helps you create a budget and organize your expenses. Some useful features are only available with their paid plan that costs $4.99 per month.
Goodbudget – A good app for helping you keep track of income, expenses, and savings. They have a free version, and a paid plan that costs $5 per month.
You Need a Budget (YNAB) – An app that doesn’t only show income and expenses but tries to help you save and pay off debt. It costs $11.99 per month but you can try it for free for 34 days.
Personal Capital – More than just a free budget tracking app. They can also help you keep an eye on your investments, and plan for your retirement.
EveryDollar – A free app that helps you create your first budget in less than 10 minutes. They also offer a paid version where you can connect your bank account to the app. The paid version costs $99 a year but they do offer a free 15-day trial.
Not everybody is comfortable using a budget app. Although they are generally considered to be pretty safe to use, you may prefer using a worksheet or spreadsheet instead.
Here’s a list of budget templates you can download.
xUSD Budget Template – This is our own budget template. It’s an Excel spreadsheet that separates all expenses into need and wants. It also covers savings and investments. It’s 100% free and very easy to customize.
Microsoft Office Budget Templates – Microsoft offers several Excel spreadsheets. Some are free to download while others require you to have a Microsoft 365 subscription.
Vertex42 Budget Templates – Vertex42 offers several free Excel worksheets you can download. Their templates also work with OpenOffice and Google Spreadsheets.
The Consumer Financial Protection Bureau has a couple of useful, although basic, PDF templates you can download. They are:
Spending Tracker – You can use it to consider what’s important to you.
Income and Benefits Tracker – A weekly income and benefits planning tool.
Monthly Budget – A budget tool to see how much you make and spend each month.
The Federal Trade Commission has a helpful PDF template you can download. It covers various budget categories, such as housing, food, transportation, health, and finance. Here’s the download link: Make a Budget Worksheet.
Top 10 Budgeting Tips
Many people start a budget with the best of intentions but find it difficult to stick to it. Some don’t even get past the first month and try to convince themselves it’s a waste of time and doesn’t work.
After reading this article I’m sure you’ll agree that having a budget and sticking to it is important. Starting something new isn’t always easy. Budgeting, like many other things in life, gets easier over time.
Once you realize you’re in control of your money budgeting can become a fun experience.
As we get to the end of the article I would like to leave you with 10 final tips. Tips that will help you budget like a pro.
- Choose the right budgeting tool to use – It doesn’t really matter if you do your budget using an app, or a template you’ve downloaded. If doing it on the back of a cigarette box works for you then do it. By using a tool you feel comfortable using, your budgeting experience will be more positive.
- Your budget isn’t meant to deprive you of life’s little pleasures – If budgeting makes you feel sorry for yourself, you’re doing it wrong. You can and should include non-essential things you want in your budget. The only trick is to maintain a healthy balance between your needs, wants, and savings.
- Don’t get stuck on an item – If you’re not sure whether to include an item or not, or how much to budget for it, move on. You can always get back to that item later. Don’t waste too much time on it or allow it to frustrate you.
- Update your actual expenses regularly – Don’t try to remember everything you’ve spent money on in your head. Don’t keep all your receipts in a box and try to update your budget at a later date. If possible, update your budget as and when you spend money. If you can’t do it on a daily basis then try to do it at least once a week.
- Use a debit card and leave your credit card at home – Wherever possible, use cash or a debit card to pay for your purchases. The advantage of a debit card is that your transactions appear on your bank statement. This is helpful if you lose a receipt, and it’s also safer than carrying cash. Try to avoid using your credit card.
- Pay yourself first – Don’t only try to save whatever money you have left at the end of the month. You’ll find you often have nothing left to save by the end of the month. Perhaps you can’t save 10% or 20% of your income after tax right now. Try to save what you can and do it before you start spending money on other budget items.
- Pay more than your minimum debt payments – The sooner you can get out of debt, especially high interest debt such as credit cards, the better. By only making the minimum payment due every month it will take you a long time to settle your account. Try to pay a little bit more every month, even if it’s just 5% or 10% extra.
- Set SMART goals – SMART is an acronym for Specific, Measurable, Achievable, Realistic, and Timely. Use your budget to set SMART goals and not just to manage your income vs expenses. This way it becomes a valuable tool. For example, set a goal to pay off your VISA credit card within 10 months.
- Don’t overcomplicate things – The simpler you keep your budget, the easier it will be to manage. All expenses can be separated into needs (essential items) and wants (non-essential items). Use the last month’s expenses as a starting guide and make an educated guess about items you’re not sure about.
- Your budget must be flexible but realistic – You can add any item to your budget, and you can change it as often as you like. But, don’t put something in your budget that’s highly unlikely to happen. Budgeting is not an exact science but try to keep your budget as realistic as you can.
At xUSD we believe personal finance requires a balanced approach. The key areas to focus on are making money, saving money, investing, and paying off debt. You can’t only focus on one of these areas. You have to manage all of them.
By having a budget you’re able to link all of these important personal finance areas together in one place. Your budget doesn’t only give you a good overview of them, it’s also a useful tool to help you manage them.
By learning how to make a budget you’re taking an important step towards managing your personal finances.
Please let me know in the comments below what part of the article you found the most useful.
Welcome to My Blog!
I’m Casper du Toit, founder of xUSD.com.
Are you worried you may not be able to retire comfortably one day and might outlive your savings? It’s never too late to get financially savvy. My mission is to help you take control of your finances, even if you think you’ve left it too late.