Is your idea of a budget simply spending till your checking account is nearly empty? Or worse, till your credit limit is exhausted? If so, you may be thinking of your budget simply as the limits on your financial resources, and not as a tool to take control of your financial future. If you would like a budget that is based more on planning than on reacting, try these six steps:
1. Track your expenses
Save a receipt for everything you buy and a copy of every bill you pay, and at the end of the day, list the item and the amount on a spreadsheet or into the budgeting software of your choice. This will become the building block for your budget, but the consciousness that comes with this kind of tracking may also make you think twice about certain expenses.
2. Think ahead
The above exercise should give you an idea of what you routinely spend from month to month, but next you have to think ahead about less-routine expenses. For example, how long will it be before you next have to buy a car? Is there a vacation in your future, or perhaps some home repairs? Estimate the cost of these items and add them in alongside your routine expenses, to see what your budget will look like when these things start to occur.
3. Budget for savings
Too often, people look at budgeting simply as a method of planning spending, but it should also be a method of planning savings. If you define savings merely as what's left over after all the spending is done, then you will likely find your savings to be sporadic and inadequate. Build a healthy contribution to a retirement saving account into your budget. That will make it harder to stretch your dollars over your other expenses, but it will give long-term savings a fighting chance of competing for attention alongside all those other demands.
4. Build a buffer
Besides long-term retirement savings, try to build up a buffer of a few months' worth of expenses. This will allow you to deal with unexpected expenses without completely throwing off your planned budget.
5. Project cash flow
So far, this exercise has focused on outflows, but now it's time to take a look at your income. Make a projection of your household after-tax income over the next few years. Factor in expected wage increases, but be realistic and be sure to account for any increase in taxes that would result. You should now have the basis for comparing income and outflow over the next few years.
6. Cut expenses till cash flow is positive
Even if you've been making ends meet from month to month, you might be surprised to find that adding in retirement savings plus anticipating non-routine expenses results in negative cash flow when you line up your income and your outflows. Don't panic -- foreseeing problems like that is one of the purposes of budgeting. Now you have to make some hard choices about what expenses to cut, but this way you can make planned choices, rather than having choices forced on you when your money runs out.