Our theme on the blog this month is finances.
Last week, I shared my Finance Friday Workflow. Today, I thought we'd take a step back and talk about budgeting.
I know, not everyone’s favorite thing.
Budgets often feel restricting, telling us where we can and can’t spend money. But what if instead of feeling like limits, it felt like freedom?
Some financial experts recommend thinking of your budget as a spending plan. By dividing your income across different spending categories, you’re basically giving yourself an allowance each month and permission to spend money.
And not just on utilities and groceries, but on fun things like eating out, entertainment, travel, and professional development.
If you’ve never sat down and worked out a budget on paper (and I mean that literally), this post is for you.
Today, you’ll learn about budgeting basics (get ready to write down some numbers!) and a few of our favorite budgeting resources to help you take the next steps in planning your personal and/or business budget for the coming year.
*Disclosure: We get commissions for purchases made through links in this post.
Let's start at the beginning.
Maybe you've found yourself asking these questions in your business:
How do I know how much to pay myself?
How do you budget when your income is inconsistent from month to month?
Am I saving enough for retirement?
If you've never used a budget before, you might be unsure how to estimate your income and expenses for the months ahead (especially if your income is seasonal).
If this is you, we recommend starting by reviewing your income and expenses for the past 3-6 months (or a year, if you can) and getting some averages you can use to plan for the future.
In fact, a helpful exercise is doing a money audit.
The Money Audit
Take out a blank piece of paper and make two columns.
On the left side, write down how much you think you made and spent in the past three months. Total your income from paychecks, gigs, lessons, sales, and any other way you made money.
Then, think about things you spent money on: business expenses (software, equipment, payment processing fees, materials, sheet music, hosting fees, etc.) and personal expenses (food and dining out, gas, rent and utilities, travel, personal care, health & fitness, and entertainment).
The goal is to do all this from memory without looking at your bank or credit card statements to verify. That will come in the next step.
Once you have estimated your income and expenses for the past three months, dig into your bank and credit card statements and write down how much you actually made and spent on the right side of the page.
Compare the numbers. What do you see? What can you learn from this?
Maybe your income estimates were fairly accurate (it's helpful if you have some consistent income streams that pay you the same amount bi-weekly or monthly). But most often, we underestimate how much we spend.
We forget about the trips to Starbucks, that $8 monthly subscription, fast food, and all those Amazon purchases.
The 50/30/20 Rule of Spending
If you're like me, you may be wondering, "How much should I be spending? Give me a percentage."
In an article on TIAA, personal finance journalist Paula Pant outlines a simple rule for keeping spending in check. She calls it the "50/30/20 Rule."
50% or less of your income should go toward necessities
30% or less should go toward discretionary spending
20% or more should go to savings (source)
How do your numbers check out for the past three months?
This is where we recommend starting with your budget. Use these percentages as a framework for planning your income and expenses for the year.
How to Start (and Keep) a Budget
Step 1 - Calculate Your Annual "Need"
Include things like rent or mortgage, renter's or homeowner's insurance, utilities, groceries, basic clothing, car payment, car insurance, gas, and cell phone bill.
These should be bare-bones, essential items only.
Investopedia explains it this way:
"Expenses are divided into several categories, namely non-discretionary and discretionary. While non-discretionary expenses are considered mandatory—housing, taxes, debt, and groceries—discretionary expenses are any costs incurred above and beyond what is deemed necessary. These are generally considered wants, while non-discretionary expenses are usually referred to as needs." (source)
Step 2 - Estimate Your Annual Take-Home Pay
Double the number from Step 1. This is how much money you need in take-home pay each year.
Step 3 - Divide the Remaining Amount
Take 20% of your total income to put toward retirement and saving goals. This may include: emergency fund, house, car, instrument, travel, HSA, and retirement.
The remaining 30% is for discretionary spending. This may include: dining out, entertainment, additional clothing or personal care items, home decor, etc.
These are your "wants," the luxury items you buy, and the way you treat yourself.
Investopedia notes, "Discretionary expenses rarely have anything to do with a business or household's day-to-day operations and, instead, have to do with lifestyle and choice." (source)
This is a helpful, big-picture way to organize your personal finances and keep your spending in check. From here, you can go into each category (Need, Want, Save) and add more specifics. For instance, you might divide your savings amount into four different accounts and set up monthly transfers.
A Note for Self-Employed Musicians:
If you're creating a budget for your business, you'll need to factor in taxes, overhead, and business expenses to set an income goal.
Here's what those percentages might look like for product-based businesses:
40% or less goes to labor & expenses (material costs + your time and/or your employees’ time)
30% or less goes to overhead (this could end up being 5-10% for an online business, which means more owner’s pay or business profit!)
20% or more goes to owner's pay (your take-home pay number from Step 2 above)
10% goes to taxes*
Here’s what those percentages might look like for service-based businesses:
20% or less goes to labor & expenses (this may include only your time—your employee working wage, which may be $15-$20/hr.)
10% or less goes to overhead
50% or more goes to owner's pay (your take-home pay number from Step 2 above)
20% goes to taxes*
If you run an online or service-based business with little overhead and few expenses, your take-home pay could be closer to 60% of your business income. It all depends on how much you're spending in your business.
We’ll talk more about this in next week’s post on how to set profitable pricing as a music freelancer.
*The tax percentages shown here work only if you’re spending and taking home these percentages. If you’re taking home more, you’ll need to set aside more for taxes. We recommend 25-30% of your owner’s pay, if that’s easier to calculate.
Budgeting Tools & Resources
Let's talk about budgeting tools, because there are some great ones out there that make managing your budget on a weekly or monthly basis much easier than wrangling with an Excel spreadsheet.
CFO Starter Kit (More with Money)
This is a free suite of spreadsheets based on recommendations in Mike Michalowicz’s book, Profit First. The best part is the calculations are built-in (which makes budgeting and allocating your business income even easier!).
Templates include:
Budget & Pay Calculator
Revenue Goal Calculator
One Bank Account Profit First Tracker
Simple Service Pricing Calculator
The Simple Revenue Planner
The Cash Flow Forecast Tool
The Monthly Investment Tracker
You Need a Budget
A popular budget app based on a simple 4-rule method that will help you "organize your finances, demolish your debt, save piles of cash, and reach your financial goals faster."
Similar to the Dave Ramsey method, if you're familiar with that, YNAB uses a "digital envelope" system to help you assign every dollar to a specific place in your budget.
They offer lots of educational resources on their website. For instance, here's a breakdown of the Four Rules with related articles.
YNAB is free for 34 days and $14.99/mo. after that.
Credit Karma (Formerly Mint)
Owned by Intuit (the same company that owns TurboTax and Quickbooks), this free tool helps you track your income and spending, set budgets and savings goals, estimate your retirement savings, and more.
I love that you can see transactions across all of your accounts (credit cards, banks, loans) at once; this saves you from having to log in to each account every month to review statements.
This is also a great way to categorize your expenses so you can see exactly how much you spend on things like food and dining vs. entertainment vs. home improvement. We use this tool to evaluate our spending from the previous year when planning our income and spending at the beginning of the year.
