A new year presents a fresh opportunity to take control of your financial situation. One of the most important steps towards success is to have a good understanding of how your money flows in and out. Ideally what you need to do is create a situation where more is flowing in than out. Creating a budget allows you the chance to get back control of your money.
A budget can help you to:
- Show your regular and reliable income sources
- Identify the key expenses that you must meet each month
- Get an idea of how to allocate your income to properly meet expenses
- Identify areas where you may be able to save money
- Identify those expenses where you should be looking to get better value
- Identify additional income sources
The problem most people have is they live month-to-month and simply pay their bills when they arrive. Unfortunately if you don’t plan ahead, it can be impossible to pay the bills and can find yourself in debt. This is a situation you want to avoid at all costs, because the sooner you are free from debt, the easier your life becomes.
Setting up a budget that works for you is simple, just follow these 5 steps.
Hopefully you’re not in the habit of throwing your bills in the trash after you’ve paid them (and it’s even worse if you do that before you’ve paid them!). Throwing away your bills is not only a security risk, it also deprives you of an important reference source for your budget-making task.
It’s easy to over-complicate things if you try to skip the basic steps. Start by making a list of all your regular income sources. This should be easy, because for most people that will be only one (your job). People who have more than one income source tend to already know how to make a budget, or they pay a financial planner to do everything for them.
After that strenuous task of listing all your regular income sources, you will then need to make a list of all your regular expenses.
Finally, make a list of annual or half-annual expenses. These are major expenses that you pay once or twice a year. That means things like council rates, car registration, or insurance premiums. Don’t include things that are renewed less often like passports and driver’s licenses.
Now using the bills you gathered in step one, take note of the total amount you paid to each different kind of expense (home loan/rent, car payments, electricity, water, etc). Just add them up and when you have the total, divide it by 12 and write that number next to the item on your list. This will be the average monthly cost for that item.
You can do this the old way with paper, pencil and ruler, or you can use a spreadsheet on a computer. You will need 14 columns and as many rows as you have items, plus seven additional rows.
Starting from the second cell in the top row, put in the month titles from January to December. Then in the last cell on the top row, put the word “Total”. If you have done that correctly, it should looks something like this:
Next, you add the “Income” title in the second cell of the first column. Under this, list each of your regular income sources (ignoring any non-regular sources like tax returns). Then write “Total” in the first cell of the next row. Leave a blank row, and below this add the “R Exp” title. Then list all your regular expenses. Now your table should look kind of like this:
The next step is to add in the monthly amounts for all the income and expenses. Once you done this and the totals have been calculated, you may think you’ve finished, but that’s not quite true. You still have two more steps to do.
For the months of January, February, June, July, August, and December, increase the amounts for electricity and water by 20%. This helps to reduce the potential shock of unexpectedly high bills that are likely to result during those peak usage months (if you live in Darwin or northern Queensland, you can ignore this requirement). Groceries also usually increase by at least 20% in December.
These are the big ticket non-regular expenses that happen only once or twice per year. Following another blank line, add the title “S Exp”, followed by the titles for each special expense. Then put the full amount in you expect to pay for each in the correct month that the payment for them is due.
Leave one blank row, then put the title “Total”. Total all the expenses into this row. Finally, you add another blank row, and then put the title “Disposable” in the first cell of the next row. Along this row, you’ll put the calculated difference between total income for the month and total expenses for the month. Here is what you should see:
Now that you have your budget, you can see how to allocate your income to meet your expenses. You should stick to this rigidly, if you want your budgeting to be worthwhile. The amount showing as disposable is the amount you can afford to spend on clothing, entertainment, restaurant meals, and other such things.
Many budget plans include these items as expenses, but they shouldn’t because they’re not things you should be planning to spend on. They’re things you should be buying only when you absolutely have to, and you should spend the least amount on them that you can. “Entertainment” is certainly not something you should be regularly spending on until you’ve achieved your financial goal.
From the example given, you can see there are problems with disposable income in February, March, June, July, September and December. This shows how a budget plan can help, because with this information you will know that you should reserve some of your disposable income from January, May, August, and November to help carry you through the bad months.
If you decided to be extremely frugal, then with over $8,000 of disposable income per year, you could actually afford to invest an average of $100 per week in stocks without it making too much of an impact on your lifestyle. This $100 per week investment at 15% monthly compounding interest would be worth $36,272.68 after five years, $111,862.92 after 10 years, and $606,781.99 after 20 years. After just four more years, you’d have over $1 million. Without a budget, you’d never know you could afford to do that.
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