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Pencil and Paper: Building a basic budget

Via Flickr, by user quacktaculous. Used under Creative Commons License.

So you’re ready to become master of your financial life, and you know that the first step in doing that is to make a budget. That’s great. So what do you need to get started?

A pencil, a pad of paper and a calculator.

Budgeting can be as simple or as complicated as you want it to be. In general, the more complicated your life is, the more complex your budget will be. So if you’re single and have little responsibility, you can create an effective budget on paper in half an hour or so. If you have kids, retirement investments and a home mortgage, you may want to build a more detailed budget on a computer spreadsheet (more on that in a future article).

The bad news about building a budget is that it involves a lot of math; the good news is that the math is so simple, a third-grader could do it. With a writing utensil and a decent understanding of your income and spending, you can put together a simple budget that will serve you remarkably well.

The basic idea of a budget is this: You write down your income at the top of the page, and then list your monthly expenses below. Make sure you use your net income — that is, the amount of money you take home in each paycheck after taxes, insurance premiums and retirement savings are withheld. Often called your “take-home pay,” this is the amount of income that really matters in your budget. If you try to budget based on your gross income (the overall amount of your salary), you’ll end up spending money that you don’t have real access to — a sure recipe for disaster.

Once you’ve got your real monthly net income written down, create a three-column list going down the page. In the first column, list the name of each expense — “rent,” “food,” “phone bill,” etc. In the second column, list the monthly payment associated with that expense (if that amount varies from month to month, write in the maximum). Then subtract the expense from the total income at the top of your page. The figure you get is your new balance; list that in your third column.

When you write in your second expense, you’re going to subtract that amount from the balance in the third column of the previous line, and continue in that manner as you go. You’re creating a running tally, which shows how much money you have left after each budget item.

What should show up in your budget? Common items include:

  • Mortgage/rent
  • Electricity
  • Natural Gas
  • Water
  • Phone
  • Cable
  • Groceries
  • Dining out
  • Auto Fuel
  • Car insurance
  • Tithe
  • Giving/charity

You could probably stop here, and have a picture of your average monthly spending. But is it a complete budget? No — you haven’t yet accounted for irregular expenses that you’ll have to pay at certain times of the year. Remember, part of building a budget is planning for the future, so you need to factor in additional categories such as:

  • Clothing
  • Car registration tax
  • AAA membership
  • Car repairs and maintenance
  • Home decor and repairs
  • Hair care
  • Medical care, dental care and medication
  • Christmas gifts
  • Miscellaneous gifts (birthdays, anniversaries, graduations, etc.)
  • Other miscellaneous spending

For these irregular expenses, figure up the total of what you will spend in each category for the year, then divide that total by 12. The result will be the monthly budget amount for that category — even though you don’t actually spend that money every month, setting it aside in your budget will ensure that you have the money available when the bill comes due.

By the time you’ve listed all these categories and done all of the computations, you should begin to get an accurate picture of your monthly financial life. You”ll see quickly if you’re overspending (your Column 3 runs into negative numbers), or if you have extra money to save, invest or pay off debt.

With a good snapshot of your financial life in place, you can begin to live strategically and make your money obey you. Who’s the master now?

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Trackbacks

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All content on this site is given on a general basis and is intended for informational use only. The content does not reflect any professional legal, investing, accounting or tax advice, and should not be used as the sole basis for making financial decisions. Always consult a certified financial professional before investing.
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