We’re already a few months away from the new year. Did you adhere to your new year’s resolution? Don’t feel guilty if you didn’t; most people don’t. That’s mostly because these resolutions are made spur of the moment and haven’t been well thought out. That’s not a recipe for success when looking to achieve a goal. In order to achieve such success, it’s much easier when you have taken time to consider and prepare. One way to prepare: creating a budget.
Budgets are an essential tool that can help make your dreams a reality. Whatever your goals are, they often require financial backing. Creating and adhering to a budget will help make your wealth planning goals attainable.
Step 1: Income
The first step of establishing any budget is to know how much income you are working with, ideally on a monthly basis. Make sure when you are calculating your monthly income that you don’t leave anything out, things like passive income, side jobs, etc. A successful budget considers all your earnings.
Step 2: Identify Fixed Expenses
Make a list of all of your monthly financial responsibilities. Start with identifying all your fixed expenses, or non-discretionary expenses. These are all your monthly expenses that must be paid. Examples of non-discretionary expenses are housing, loans, car payments, groceries, gas, and water bills. Some of these, like groceries, can be hard to estimate. Go through your financial statements for the previous 1-3 months; that will help you to narrow down an approximate number. This can be a scary process, but establishing an accurate baseline helps you to create an effective budget.
Step 3: Establish Goals
With your income and expenses locked down, the next step is to establish a financial goal. This is a critical step, as it is the lifeblood of any budget. By having a goal, you can prioritize your spending. A few good questions to ask yourself when building financial goals:
- What do I want to achieve?
- What are my values?
- What does success look like to me?
- Are my goals SMART?
- What does wealth mean to me?
- Is this goal too big? Too small?
- How much time will it take to reach this goal?
These are just a few questions that can help you define your financial goals. For even more helpful questions, this article can help. Once you establish your financial goal, make sure you write it down and give it a deadline. Whether it be three years or three months, having a deadline pushes you to achieve it.
Step: 4 Outline Discretionary Expenses
These expenses are different than the non-discretionary expenses discussed earlier. These are going to be the non-essential expenses – the stuff you currently pay for that isn’t completely necessary. These are expenses like dining out, vacations, and care products. These expenses fluctuate based on what you can afford, which is why we are addressing them after the non-discretionary expenses and financial goals. Discretionary expenses are a critical part of any budget. If you don’t give yourself enough leeway to do the things you want to do, it can become very easy to break the budget. So make sure you spend a good amount of time balancing how much of your budget you can allocate towards these expenses.
Step 5: Combine Income and Expenses
Now that you have a consolidated list of expenses and have established a monthly income, you need to subtract the expenses from your income. There are three possible outcomes: positive, break even, and negative.
A positive number means you have more money than you are spending. This is good, but you will want to go back and adjust some of the numbers so that you have every dollar accounted for. A budget is a mission plan, and a good mission plan considers every aspect.
The budget breaking even means you have exactly enough money based on your expenses. Based on your discretionary expenses, this might mean you adjust a few of those expenses to find a margin you can utilize for unplanned purchases.
A negative number means you are spending more than you are making. Obviously, this is not where you want your budget. If you have a negative budget, it means you need to find a way to reduce expenses or increase income. Go back into your budget and make sure you have the essentials covered and then make sure you are prioritizing your financial health over discretionary expenses.
Step 6: Implement and Adjust
After you have nailed down your budget, you need to make sure you are sticking to it. Make sure you are tracking all your purchases early on. A successful budget is a powerful tool, but you need to stick to it. Your circumstances will change, and so will your budget. Making sure you are sticking to your goals and updating the budget as changes happen can make sure you are achieving your financial goals.
Adam Randle is a writer with First Western. When he’s not writing or thinking about finance, he enjoys fishing and classic cars.