However, it is easier said than done, that’s why this guide is here to help you go through the process step-by-step.
What is Budgeting?
Despite what many believe, budgeting isn’t all about restricting what you spend money on and cutting out all the fun in your life. It’s really about understanding how much money you have, where it goes and then planning how to allocate those funds best.
More specifically, a budget is about analyzing and planning how much money you make and how much you spend. Can you name a successful business that doesn’t track its income and expenses? I don’t think so. The same goes for personal finances. Without a well-defined budget and monthly spending management plan, the road to financial freedom can be a lot more difficult than you think.
The biggest fear most people have when budgeting is cutting back on all the fun things they do, like occasionally drinking coffee, eating out, having a movie night, or going on holiday to see Grandma. This is the wrong way to think about a budget because a budget is a tool, not a punishment. A budget can help you achieve financial freedom if you get the idea right.
- Track Your Spending
For effective budgeting and money-saving, surprisingly for some, the first step is not to create a budget, but actually, track what you spend each month. It is a good idea to get a sense of your expenses (for about 3 months).
To start, gather all your financial documents – such as Bank statements, Loan bills, Paystubs & Utilities bills. Access to all information about your income and expenses is important because a key part of the budgeting process is creating a monthly average. So, the more information you uncover, the better.
Once you get a brief idea of your monthly expenses, you can divide each expense into categories of Mandatory and Discretionary spending. Things such as rent will go into the first category and they should be prioritized over other spendings. Once you got that down, it’s time to move on to the next stage – which is the actual budgeting.
- Making a Budget
As mentioned above, budgeting should start by listing your monthly income. Typically, your budget includes 4 weeks’ worth of take-home pay – which is actually what you get after tax. You should always plan ahead, especially when starting a new job. You can speed up the process by searching for an online payroll calculator on Google.
However, not everyone has the same income arrangement. For example, if you work as a freelancer, your monthly income may fluctuate. In this case, list the lowest or lowest possible salary and base your budget on it. The remaining amount can be added to the checkings account as a buffer. This applies to other sources of income as well, such as child support or benefits, include these as well. Record this total income as a monthly amount.
As mentioned earlier, you should divide your spending into two categories: Mandatory Spending and Discretionary Spending. The first category refers to all the costs that are related to your safety and survival. That includes, but is not limited to:
- Mortgage or rent.
- Electricity, gas & water bills.
- Groceries
- Transportation
For Discretionary Spending, these are the expenses that are regarded as non-essential or unnecessary. They should be the amount after you have deducted all the mandatory spendings from your income, not before. Such expenses include:
- Entertainment Subscription
- Dining out & bars
- Shopping
To help determine your Discretionary Spending, you can make a column for your income (using a spreadsheet). Then add all the necessary expenses together, subtract the amount from your income. The amount left will be your Discretionary Funds. Depending on your goals, you can also add a savings amount to your necessary category, then, you can freely add any expenses that are not necessary, but still within the budget.
- Fixed vs. Variable Expenses
Besides from expenses categories. You should be mindful whether your spendings are Fixed, or Variable Expense.
A fixed expense is spending that you pay the same amount each time. That includes items such as mortgage or rent payments, car payments, and internet services. If you pay with standard credit card payments, include that amount plus any other significant expenses that remain the same each month. If you plan to save a certain amount each month or pay off a certain amount of debt, include savings and debt repayment as fixed expenses.
Variable spendings tend to change monthly – things like food shopping, petrol, nightlife, and eating out. Start by allocating costs to each category, starting with fixed costs. Then estimate how much you should spend per month on variable costs.
If you’re not sure how much you’ve spent in each category, look at how much you’ve spent on your credit card or bank over the past 2-3 months to get a rough estimate.
One good tip: If you don’t have an emergency fund, include a category for “unexpected expenses” that could derail your budget in the month.
- Some Tips
If one of the following scenarios is happening, you should consider making a major change to your lifestyle:
- Your monthly mortgage/rent takes up 30% or more of your salary. You might consider finding a roommate to split the cost, or moving to a cheaper place.
- Your food shopping cost more than £220 per person. If you’re looking to save money, you can consider more economical grocery shopping options, such as buying in bulk, buying cheap-branded products, or going to a cheaper store.
Here are Some Other Useful Tips for Budgeting as Well
- Pay by credit card only if you have money to pay at the end of the month. Otherwise, you will have to pay interest on the things you buy.
- If you only get paid once a month and have cash flow issues, split those payments into a weekly basis and keep the money you plan to use for the rest of the weeks in a separate account until you need it.
- If you work on commission, or freelance (especially paid by projects), be aggressive in saving money to help cover the periods when the market is slow and there isn’t much work for you.
- Adjust your budget each month if you overestimated or underestimated your spending. Beware of large expenses that occur every few months, such as insurance premiums.
Our circumstances and priorities change – job change, moving away, and having children. Make time with yourself every few months, closely examine and evaluate your budget and make sure it fits your current goals and reality.
If you’ve already got your numbers typed in a website or a spreadsheet, it’ll be easier to adjust your budget categories, and see where you can create an extra room or prioritize one spending over another.
Remember, your budget should work for you, not the other way around.
- Still, Struggling? Take a Look at your Transport
According to the data from RAC, regarding the cost of travel in the last 10 years, the cost of overall transport rose 24% from 2012 to 2021 in the UK. With bus and coach fares, they had a 67% spike in 2021 compared to 2012. You can imagine how hefty the expenses are.
The same applies to your car if you found yourself spending more than 15% of your salary towards your monthly car expenses. You should consider alternative options – such as car-sharing at work and taking a bus or bike. To go even further, if possible, you could consider moving to a nearby location of your work to reduce the time and cost of traveling, or you could sell your car.
In terms of selling your car, there are many options available depending on your priorities. For example, if your current car is too pricey to maintain, you could seek a more budget option to lower the cost. Consider using a part exchange service to sell your current car and exchange for a new one – preferably a more budget-friendly option, in this case. You can look at dealerships or platforms that advertise “we buy any car” for that service and you’d be good to go.
Ending Note
To sum it up, budgeting is a useful tool to guide you to financial freedom. Small things such as canceling your streaming subscription, or eating out less in a month could build up and save you a significant amount in the long run. The amount you saved allows you to spend a few extra dollars on things like retirement savings or investments.
Don’t forget to revise your budget each month and account for changes in your income or expenses. As your financial situation evolves, your budget will also change to create a healthier financial lifestyle.
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