(Tiny Tips) Budget plans and tracks income and expenses over a specific period of time. Businesses and governments rely on budgets to track income and expenses, but you probably know them best as a tool for managing your finances.
There are different types of budgeting systems and methods. If you’re wondering how to get started with a budget or why a budget is so important, this guide can help.
Key Takeaways
- A budget is a plan for managing income and expenses over a certain period of time.
- There are different types of budgets you can use to manage your money.
- A budget helps you track your spending and stay within your means.
- When creating a budget, choose the budgeting method or system that works best for you.
How to create a budget
Creating a budget is relatively easy. The basic process of creating a budget is as follows:
- Add up the monthly income you expect to receive from all sources
- Breakdown and total of expected monthly expenses
- Subtract expenses from income
Your goal should be to understand your income and develop a spending plan.
Step 1: Add up your monthly income
Consider all possible sources of income: salary from a job, payments from clients (if you freelance or gig), or sales (if you run your own business). Also consider this if you receive regular disability, Social Security, alimony, or child support payments.
List all sources of income and the amount you typically receive each month. Use the take-home amount, not the amount you earned before taxes. If the amount you receive changes from month to month, try averaging out the amount.
Step 2: Add monthly charges
Next, list all of your regular monthly expenses. Consider fixed costs like rent, mortgage or insurance. Then list your variable expenses—the ones that change from month to month. Some examples include groceries (groceries and restaurant purchases), gas, and entertainment.
Try to keep track of everything you spend money on. You can use a dedicated app, budgeting software, or just pen and paper. Reviewing your bank and credit card statements can help you remember forgotten charges.
Step 3: Subtract expenses from income
Finally, subtract your total monthly expenses from your total monthly income. If you think you’ll have money left over after completing this calculation, you’re ahead of the game.
If you’re worried you’re not spending enough, re-evaluate your spending and look for areas you can reduce or eliminate. At this point, it is particularly important to compare wants and needs.
How to stick to your budget
Creating a budget is one thing; It’s another thing to stick with it. Sticking to your budget may require the following actions:
- Track expenses regularly
- If you want to overspend using a debit or credit card, please pay with cash
- Weekly budget check-ins to ensure you’re sticking to your budget goals
- Check your budget once a month to see if your income or expenses have changed
- Give yourself a small reward for sticking to your monthly budget
If you have trouble sticking to your budget, consider an accountability partner who can encourage, advise, and motivate you to stick to your budget plan.
Notes
When choosing a responsible partner, stay away from people who may judge your spending decisions or offer unconstructive advice.
Types of Budgets
In its simplest form, a budget plans and compares income and expenses over a specific period of time. A budget requires you to subtract your expenses from your income. If you have money left over, you have a surplus. If your costs exceed your income, you will run a deficit. When expenses and income are equal, it is a balanced budget.
A personal budget is a budget that people create to manage their income and expenses. They are often more complex and require less expense than corporate or government budgets, which is something to keep in mind. Different budgeting methods may work best for different people.
Zero based budgeting
Zero-based budgeting is budgeting your income down to the last dollar. Our goal is to put every dollar to work so that no money is wasted or left behind. Businesses, governments, and other organizations can also use this budgeting method.
Cash envelope budget
Cash envelope budgeting involves assigning specific budget categories to individual envelopes. Each envelope contains an amount allocated to that budget category. Once you’ve used all the cash in the envelope, you can’t spend anything more in that month’s budget category.
Percent-based budget
Percent budgeting involves allocating funds to different budgets. For example, you could allocate 50% of your income to wants, 30% to wants, and 20% to savings and paying down debt. U.S. Senator Elizabeth Warren and her daughter Amelia Tyagi Warren wrote a best-selling book on the 50/30/20 budget rule in 2005 called “Your Full Value: The Ultimate Lifetime Financial Plan.” 1
Budgets can also be flexible and you can set your own budget rules at any time. “For example, you might decide to donate 3 to 10 percent of your net income to charity.
Notes
Budgeting apps can make managing your income and expenses easier; it’s important to know which budgeting method an app uses.
Pros and Cons of Budgeting
Pros
- Control spending and saving
- Helps to track spending
- Can reduce financial stress
Cons
- Budgets can feel restrictive
- Requires commitment
- Depend on impulse control
Pros Explained
- Allows you to control spending and saving: You decide which budget categories to include and how much you want to spend in each category. Additionally, if you commit to saving in a specific designated savings account (such as “Hawaiian Vacation”), you may develop a regular saving habit.
- Helps track spending: If you’re facing overspending, a budget can keep track of where your money is going so you can identify potentially harmful spending habits and cut back on unnecessary spending.
- Can Reduce Financial Stress: A budget can reduce stress by providing tools to plan and build emergency savings, giving you greater peace of mind when unexpected expenses arise.
Cons Explained
- Feeling Constrained: One of the biggest budget issues many people face is feeling like they are constrained in some way. Offset this by leaving room for “fun money” in your budget so you don’t feel deprived.
- Requires commitment: A budget can help you take control of your finances—but only if you stick to the plan you made. If you don’t stick to your budget, you may not reap the benefits of your budget.
- Depends on impulse control: If you’re used to spending money on a whim, you may want to develop new habits and check your budget before going out with friends or wearing new clothes.
Notes
If your budget calls for savings, consider investing your emergency fund in a high-yield savings account, which offers higher interest rates and lower fees.
Personal budget vs. Company budget
There is a big difference between a personal budget and a business budget. A personal budget refers to how you spend your personal income. Typical budget categories might include housing, utilities, groceries, and transportation. When it comes to personal budgeting, most people are trying to reduce debt like loans and credit cards and may prioritize saving for retirement or emergencies.
A business budget, on the other hand, deals with the types of expenses a business typically has. Therefore, a business budget can include capital expenditures, debt service, or payroll. While companies may have cash reserves, they may not make regular contributions from budgeted funds. In a business budget, debt is not necessarily a bad thing if it is used to fund growth or expansion projects that later increase revenue.
Why you need a budget
Budgeting is very important to control your money. Without a budget, it’s easy to overspend and get into debt if you constantly resort to credit cards or loans to fill the gap.
You can try different budgeting methods to find the one that works best for you. Remember, budgeting isn’t “set it and forget it.” Review your budget regularly so you can make necessary adjustments if your income or expenses change.
Frequently Asked Questions (FAQs)
What is the difference between yearly and monthly budgets?
A monthly budget details your income and expenses each month. The annual budget reviews all income and expenses recorded during a year. If your income or expenses fluctuate significantly by month or season (for example, if you're a freelancer) and you need to see the big picture, an annual budget can be helpful. Annual budgets are also useful for monthly budgeters, but just to keep track of where your finances stand. A monthly budget more accurately reflects your current actual income or expenses.
Why is a budget important?
Budgets are important for tracking expenses and income, determining spending patterns, creating savings, and avoiding debt. A budget is a financial plan or blueprint for managing money. Without this, it's easier to overspend or accumulate debt.