After learning about the 3 Financial Principles (Live Below Your Means, Prepare for the Hurdles, and Invest in Your Future) lets tackle the first and one of the most important financial tools you will utilize to set the foundation to improve your cash management…a budget!
I was asked the other day by a friend of mine who understands the concept of living below your means but he didn’t understand exactly how to make it happen.
Creating a budget is essentially telling your money where to go and the purpose you have dedicated it to have prior to allowing the cash to slip away in careless spending!
To create your own budget we are going to divide this exercise into 3 steps. Ask yourself the following:
- What is your household income?
- What are your expenses?
- What are your short term and long term financial goals?
What is your household income?
First, we need to clearly know what the annual gross income and what the net income is for your household. Gross income is the top line amount prior to subtracting deductions, contributions to retirement accounts, taxes (social security and medicare), insurances, etc. Your net income is the “take home amount” (the money that is given to you in your direct deposit/check). You always want to live below your means and it starts with knowing what your monthly and annual net income is.
What are your expenses?
Tracking your expenses can be and will be time consuming, especially if you are utilizing a manual method like pen and paper or an excel spreadsheet. Whatever is most comfortable for you, make sure to find a method to track your day to day and month to month expenses and stick with it.
There are many categories in expenses. To name several, you have Auto & Transportation, Utilities, Education, Food & Dining, Health & Fitness, Home, Miscellaneous, and Savings. Each of these categories can go further with subcategories, as well (see the attached budgets at the end of this post for more examples).
Now, lets reflect for a moment. Take a look at your spending patterns for the past 3-6 months. Your online banking and online credit card accounts should have the capabilities to provide expense reports. If your accounts do not provide these types of reports, unfortunately you will have to download the statements and review the transactions and assign each of them to an expense category, one by one, so that you can have a clear understanding of your previous spending patterns.
Once this exercise is done, you should be able to determine how much you are spending in each category. Based on your findings, you need to reflect on what areas of opportunities you should focus on in order to improve your cash management and spending behaviors. For instance, if you’re spending way too much money on eating out at restaurants and going to bars you may want to consider being more conservative and cook at home and invite your friends to a wine night at your place. Think about the potential savings just from this category of expenses. It all comes down to self responsibility and holding yourself accountable to a new way of viewing your personal finances.
However, before you get started in setting a budget we need to ask this question first…
What are your short term and long term goals?
Are you wanting to purchase a home, a car, invest in your new startup, or build a savings/emergency accounts? Whatever that idea may be and however much money your goals will require, you need to set realistic expectations and set a time frame for accomplishing your goals. This will require you to develop a strategy and to analyze how this will impact your spending behaviors and how you need to ultimately reduce your expenses and live below your means!
As a best practice, you should save at minimum 10%-15% of your net income every month. For example, if your net income is $3,000 monthly you should be saving $300-$450 a month. Multiple that by 12 months and you are on track to saving $3,600 to $5,400 a year!
So now, crunch the numbers. How much money do you need to save in order to accomplish your goals? How will this impact your spending and what is your strategy to live below your means?
How to tie this all together?
Since we have established that you will be saving 10%-15% of your net income a month, lets crunch some numbers and finally set a conservative budget that will help you accomplish your goals!
Right off the bat, make sure to budget for your savings before considering your expenses! This will force you to live below your means:
Since we’ve already committed $300-$450 to savings as the first line item on your budget, now you are ready to create a budget for the expenses. This strategy will force you to live below your means and help you achieve your goals.
Here is an example of a budget allocation per expense category, including a 10% savings goal:
Now remember, writing a budget on paper and crunching the numbers is the easiest part. You’ve got to HOLD YOURSELF ACCOUNTABLE and take ownership of your cash management. Learn how to optimize your cash flow, be conservative with your spending, control your behaviors, prioritize your needs and your wants, and keep your mind focused on the ultimate goal!
Whether you want to build your savings accounts, purchase a home, purchase a car, invest/build a business, or save more for retirement, the responsibility is ultimately on you to make it happen!
If you are good with Excel download a free Budget Format to get started!
Download this free Monthly Family Budget