Create A Budget

Establishing a budget is a good way to manage your finances, and it's an essential first step toward building a healthy financial statement and increasing your net worth. To prepare and use a budget successfully, you'll need to plan for the expected and the unexpected — a process that involves monitoring, adjusting and controlling future income and expenses. Budgeting is a tool, and your skills will improve as you continue to use it regularly.

Budgeting Made Easier

Budgeting is a learned skill, just like learning to manage any other routine of life — from establishing an exercise program to managing a family or a career. There are times when working on it might be easier, for example, right after you've done your income taxes or completed an application for a mortgage. Most of your financial information will already have been gathered together for these two efforts. For your budget, you'll want to use your pay stubs, bank statements, credit card statements, insurance premium notices, financial management software applications and other statements that help track your cash flows for a year.

Understand Where the Money Goes

Classify all income and expenses by category per month. Examples of such categories are:

  • Inflows (salary, dividend income, interest income)
  • Outflows (annual retirement contributions, savings)
  • Fixed outflows (mortgage, property taxes, insurance)
  • Variable outflows (entertainment, food, clothing, personal care)

Convert the dollar amounts in each category to percentages of your gross income.

Now you can analyze each category. What categories tend to be consistent in amount?  Once you've identified these areas, you can use them for your future projections for that category.  

Look at each category and identify consistent patterns of expenses.

There will be monthly, quarterly and annual patterns. For example, you may see that insurance premiums are paid in the first and third quarter, monthly food expenses average $200, utility bills generally average $50 per month but are 50% higher during the fourth quarter. This is your model for standard expenses. With this pattern in mind, planning future cash flows can be more organized, limiting the surprises.

Identify which expenses are sensitive to general inflation and which are not.

For example, grocery expenses are inflation-sensitive and may increase or decrease, while a fixed-rate mortgage is not. You'll need to account for inflation-sensitive expenses when you forecast next year's budget.

Forecast next year's income on a monthly basis.

You can do this by considering plans and expectations for next year, including expected salary increases, growth in investment income, and sale of assets.

Plot expenses for the next year by month, category and dollar amount.

Make special note of the quarterly and semiannual payments. These are generally larger lump sums and can cause problems with cash flow if not factored into the plan.

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