A budget plans for and tracks income and expenses over a specific time period. Businesses and governments rely on budgets to track revenues and expenditures, but you might be most familiar with a budget as a tool for managing your finances.
Different types of budget systems and methods exist. If you're wondering how to start a budget or why doing so is essential, this guide can help.
Key Takeaways
- A budget is a plan for managing income and expenses over a set time frame.
- There are different types of budgets you can use to manage your money.
- Budgets can help you track spending and live within your means.
- When making a budget, choose a budgeting method or system that works best for you.
How To Start a Budget
Starting a budget is relatively simple. The basic process for making a budget goes like this:
- Add up the monthly income you expect from all sources
- Categorize and add up the monthly expenses you expect to pay
- Subtract expenses from income
Your goal should be to see how much you have coming in and to set a plan for what goes out.
Step 1: Add Up Monthly Income
Consider all your possible sources of income: salary from your job, payment from clients if you are a freelancer or gig worker, or sales you've made if you run your own business. If you receive regular payment for disability, Social Security, alimony, or child support, include that, too.
Make a list of each source of income and how much you typically receive per month. Use the take-home amount, not the amount you earned before taxes. If the amount you receive changes from month to month, try using an average amount instead.
Step 2: Add Up Monthly Expenses
Next, create a list of all of your regular monthly expenses. Include fixed expenses, such as rent, mortgage, or insurance. Then, list your variable expenses—the costs that change from month to month. Some examples are food (both groceries and restaurant purchases), gas, and entertainment.
Try to record everything you spend money on. You can use a special app, budgeting software, or even just pen and paper. Checking your bank and credit card statements can help remind you of any expenses you've forgotten.
Step 3: Subtract Expenses From Income
Finally, subtract your total monthly expenses from your total monthly income. You're ahead of the game if you project to have money left after performing this calculation.
If you think you’ll fall short, revisit your expenses to look for areas you can reduce or eliminate. It’s particularly critical to compare needs versus wants at this point.
How To Stick To a Budget
Making a budget is one thing; sticking to it is another. Sticking to a budget may require these actions:
- Track expenses regularly
- Pay with cash if tempted to overspend with your debit or credit card
- Complete weekly budget check-ins to ensure you're on track for your budget goals
- Review your budget once a month to see if your income or expenses have changed
- Give yourself a small reward for sticking to your budget for the month
If you struggle with staying on budget, consider an accountability partner who can offer encouragement, advice, and motivation for following your budget plan.
Note
When choosing an accountability partner, steer clear of someone likely to be judgemental of your spending choices or offer advice that isn't constructive.
Types of Budgets
In its simplest form, a budget plans for and compares income and expenses over a specified time period. Budgets require you to subtract expenses from income. If you have money left, you have a surplus. If your costs exceed income, you have a deficit. If spending and income are equal, that's a balanced budget.
Personal budgets are budgets that everyday people make to manage their income and expenses, and are generally less complicated than corporate or government budgeting, with fewer expenses to track. Varying budget approaches may work best for different people.
Zero-Based Budgeting
Zero-based budgeting involves budgeting your income down to the last dollar. The goal is to give every dollar a job so there's no money wasted or left over. Businesses, governments, and other organizations can also use this budgeting method.
Cash Envelope Budgeting
Cash envelope budgeting assigns specific budget categories to individual envelopes. Each envelope is filled with the amount allotted to that budget category. Once you spend all an envelope’s cash, you can't spend anything else in that budget category for the month.
Percentage-Based Budgeting
Percentage-based budgeting assigns money to different buckets. For example, you might allot 50% of your income to needs, 30% to wants, and 20% to savings and debt repayment. With her daughter Amelia Tyagi Warren, U.S. Senator Elizabeth Warren wrote a popular 2005 book on the 50/30/20 budget rule called “All Your Worth: The Ultimate Lifetime Money Plan.”
Budgets can be flexible, too, and you can always come up with your own budgeting “rules.” For example, you might decide you want to give 3% to 10% of your net income to charitable causes.
Note
Budgeting apps can simplify the process of managing income and expenses; it's essential to know which budget method the app uses.
Pros and Cons of Budgets
Pros
Gives control over spending and saving
Helps to track spending
Can reduce financial stress
Cons
Budgets can feel restrictive
Requires commitment
Depend on impulse control
Pros Explained
- Gives control over spending and saving: You can decide which budget categories to include and how much to spend in each category. Also, if you commit to saving for a specific named savings account (such as “Hawaii Vacation”), you may develop a regular savings habit.
- Helps track expenses: If you struggle with overspending, a budget keeps tabs on where your money goes, so you can identify potential harmful spending habits and cut unnecessary expenses.
- Can reduce financial stress: A budget can reduce stress by offering a tool for planningand building emergency savings, which is added peace of mind when an unexpected expense comes along.
Cons Explained
- Feels restrictive: One of the most significant budgeting issues many face is the sense that you somehow limit yourself. Counter that by including room in your budget for "fun money" so you don't feel deprived.
- Requires commitment: Budgets can help you get control of your finances—but only if you stick to the plan you've made. If you're not committed to your budget, you may not reap the benefits of budgeting.
- Depends on impulse control: If you’re used to spending money whenever you want, you may need to learn new habits around checking your budget before going out with friends or splurging on a new outfit.
Note
If your budget includes saving, consider keeping your nest egg in a high-yield savings account, which can offer higher rates and lower fees.
Personal Budgets vs. Corporate Budgets
Personal budgets and corporate budgets are very different. Personal budgets apply to how you spend your personal income. Typical budget categories might include housing, utilities, groceries, and transportation. For a personal budget, most people try to reduce debt such as loans and credit cards, and may emphasize saving for retirement or emergency funds.
Corporate budgets, on the other hand, deal with the types of expenses businesses typically have. So a corporate budget may include capital expenditures, debt servicing, or payroll. While businesses may have cash reserves, they may not regularly contribute to them out of budgetary funds. With a corporate budget, debt isn't necessarily a bad thing if it's being used to fund growth or expansion projects that will later increase revenues.
Why You Need a Budget
A budget is important for taking control of your money. Without a budget in place, it's easy to overspend and end up in debt if you're always turning to credit cards or loans to fill the gaps.
You can experiment with various budgeting methods to find one that works best for you. Just remember that budgets are not “set it and forget it.” Regularly review your budget to adjust as needed, should your income or expenses change.
Frequently Asked Questions (FAQs)
What is the difference between yearly and monthly budgets?
Monthly budgets detail your income and expenses one month at a time. Yearly budgets review all the income and expenses tracked over a year. An annual budget can be helpful if your income or expenses vary greatly by month or season (for example, if you’re a freelancer) and you need to look at the whole. Yearly budgets can also be useful for monthly budgeters, but only for looking at your bigger financial picture. Monthly budgets may more accurately reflect your immediate actual income or expenses.
Why is a budget important?
Budgets are essential for keeping track of expenses and income, identifying spending patterns, developing savings, and avoiding debt. A budget is a financial plan or blueprint for managing your money; without one, it may be easier to overspend or rack up debt.
