There are a number of considerations you should be aware of when creating a budget. In the first place, it is important that you know how to differentiate between income and expenses .
The first thing to know is how much money we have. That is, what are our incomes, whether personal or family.
To get started, it’s important to identify the difference between gross and net income below.
- Gross Earnings – Refers to the total amount you earn before taxes and other deductions.
- Net Income – Refers to the amount you receive after taxes and other deductions.
When budgeting, use your net income rather than your gross income , as this is the amount of money you actually have.
Add the income of your partner or other family member who contributes to household expenses.
What you should know: If you receive additional income, such as a special bonus, commission, or if you work extra hours per week, it is advisable to categorize that income as extra income. So you can convert the extra income into savings or funds to pay off debt.
Since you are clear about the total amount you have each month, it is important to identify your expenses.
There are three types of expenses: fixed expenses, variable expenses and free expenses. Find the additional detail below.
- Fixed Expenses – Expenses that we have each month that are a fixed amount, such as rent or mortgage payments.
- Variable Expenses – Expenses that we have each month but whose amount varies. For example: The expense of the supermarket, gas or electricity.
- Free Expenses – Expenses that you make at your discretion. For example: Buy clothes, eat out, buy a gift, etc.
Once we have identified our income and expenses, it is possible to see if we are spending within our means or if there are changes we can make to meet our financial commitments, live better and even reach our financial goals.
How to create a budget step by step?
A budget involves making decisions and setting limits. This can be as simple as setting a limit on the amount designated for free spending each month, or it can involve setting limits on variable spending and following a plan to reduce these expenses (spending less on electricity or water, for example).
In addition, a budget can also help redefine our fixed expenses. It may be better to pay more rent to live closer to work and drive less; or pay less for rent and buy a hybrid car to spend less on gas. The important thing is to know what our budget is to meet the payments each month without having to sacrifice other needs.
Steps to create an income plan
In order to define how much money you can spend or save, the first thing you need to do is have a clear idea of how much money you have.
- Start by evaluating your fixed income, that is, the total net income you are earning from your job. This amount is obtained after taking your gross income and deducting federal taxes, state taxes, social security, medical insurance, 401k, among others. Your employer must provide you with a document or pay stub that clearly indicates this information.
- Repeat the same procedure with the income of your partner or any other member of your family who is contributing to the household income.
- List any additional income. This can be overtime pay or a bonus at your job. Again, be sure to list the net income and not the gross income.
- List other sources of income, such as investments, rental property, child support, pension, social security payments, unemployment, etc.
- Remember that your income must be reported to the IRS, and you may have to pay tax. Consult with your tax advisor to define what amount you must set aside for the payment of your taxes. Deduct this amount from the gross amount of your income from other sources.
- Add up the net totals of your regular pay, extra pay, and income from other sources.
- Now yes, you already have the total amount you have each month.
What you should know: It is important to set aside the amount that corresponds to the payment of your taxes, to avoid spending it and then not having a way to pay it in case you have a debt. One possibility is to put this amount in your savings account and not touch it until it’s time to pay your taxes.
Steps to create a spending plan
Making a spending plan is the best way to stay in control of your finances, and you can do it very easily:
- Start by writing down the total amount you have each month.
- Deduct your monthly fixed expenses. These may include your rent or mortgage, car payment, insurance, etc.
- Deduct your monthly variable expenses. A precise way to do this is by entering the amount indicated on your electricity, gas, water, cell phone, etc., bills. Also, include as a variable expense the minimum you must pay on your credit cards.
- From the amount that remains, define how much you want to dedicate to paying debts, and how much to free expenses. For example, indicate how much you want to spend on your child’s birthday present, or on entertainment for the whole family. Also indicate if you have to buy clothes or school supplies that month. Finally, make a note of all these expenses and set limits. If you decide not to spend more than $200 on clothes, be sure to stick to your guns and don’t go overboard.
- Define the amount of money you commit to saving each month, either for emergencies or to reach your financial goals.
Set financial goals
In addition to setting your income and expenses, we recommend setting financial goals. These can be short, medium or long term.
- Short-term goals are goals that are set to be accomplished in less than two years. For example, take your family on vacation.
- Mid-term goals are goals that you want to achieve in two to five years. For example, buying a new car.
- Long-term goals are goals that you want to accomplish in more than five years. For example, save for your retirement.
When you set a goal, ask yourself the following questions:
- What is the cost of your goal?
- How much money can you save each month?
- How long will it take to reach that goal?
- What is the best savings plan?
Consult with a financial advisor to define the savings plan or type of bank account that is best for you to reach your financial goal.
Once you have the amount you commit to saving each month, be sure to add this amount to your spending plan. Pay this monthly payment as you would your fixed expenses. Give your goals the importance they deserve.
Live within your means
Taking control of your finances starts with being clear about how much you have each month and how you’re spending your money. It is necessary to make decisions and stick to them. Define where you can cut back if you need more money so you can meet your commitments while saving money for your financial goals.
On the other hand, to live better it is important not to exceed our expenses. You have to be able to differentiate between needs and tastes. For example: Do we need to buy something or do we just want it? Indulging is recommended, but it’s important to do it within your set limits.
The peace of mind that being able to meet all your payments will give you and the pride that you will feel in being able to achieve your goals are worth much more than a spontaneous pleasure that can make you go out of your budget.
Live within your means and you will see how much more you can do with your money.