Monday, January 17, 2011

Day 95 - Step 7: Make A Budget (Part I)

January 17, 2011

I have developed a guide to help you (and me!) achieve the mindset and principles required to successfully become debt free.  This is the seventh in a series of posts about my Twelve Steps to Debt Freedom.
Step 7: Make A Budget
Image: Arvind Balaraman / FreeDigitalPhotos.net
You probably didn't expect the budget part of this exercise to be all the way at Step 7!  I thought it was important to be mentally prepared, well organized and in possession of a roadmap before tackling what is usually referred to as the 'dreaded' budget.  But if you think about it, you should already have most of the information you need - take home pay, expenses, pay period - from completing Step 4: Get Organized.  The hard part is already done - now all you need to do is some additional analysis.  I have broken this post up into two parts - don't be intimidated by the length and decide to forget the plan altogether.  Trust me, most of your work is done.  Now you just need to use your head a little bit.

Just remember your ultimate goal: Pay off debt.  In order to do this, you need to either reduce your expenses or increase your income (or both).  While working on Step 7, keep your goal in mind if you start to feel frustrated or confused.  You can do this.

Part I - Opening Balance and Recurring Expenses

Put everything on paper.  After you have decided the best time period to look at your spending habits (e.g., monthly, bi-monthly, pay periods), it's time to try to get a feel for your spending patterns.  This might be better explained with screen shots.  I created a sample of the budgeting tool I use every pay period and have included screen shots and explanations.

Sample Budget - Opening Balance/Recurring Expenses
1. Bank Balance.  This budgeting tool is very similar to your checkbook register.  You want to make your starting point your bank balance as of the beginning of your budget period.  In this example, the budget period is 1/1 through 1/15 so the opening balance is from 12/31.  Make sure you take into account all purchases that haven't yet cleared your bank account.

2. Recurring expenses.  List out what you think your recurring expenses will be during that period - meaning any expense you expect to see on a regular basis.  Utilities, rent, car payment, insurance, gas, etc.  Look at old bank statements to help you remember.

3. Budgeted.  Next, determine how much you think you will spend on these recurring expense items during the month.  This amount will go in the 'Budgeted' column.  Some of the amounts should be easy to determine since it shouldn't change from month to month (for example, rent).  Other amounts you will just have to take your best guess.  Don't worry about getting it perfect.  You will find that you will get better at it as the months go on.
Analyze your recurring expenses.  Now that you have everything on paper, do you see any expenses listed that could potentially be reduced or removed completely?  For us, this was a monthly wine club, cable, and an overpriced gym membership.  Do you have any expenses that automatically come out of your paycheck each period that you haven't necessarily thought about?  Now is the time to pare down and free up as much money as you can so that you can apply more to your debt - that is what this budgeting exercise is all about.  Worst case scenario?  You cancel your cable and a month later realize you can't survive without it.  You can always get it back!  This is also a great time for you and your partner to put your heads together and make these tough decisions.  It will be a tough meeting but you will feel great when it is over.

4. Actual.  As you go through the period, update the 'Actual' column to reflect the actual amounts you spent on your recurring expenses.  Don't wait until the end of the period to do this - it is in your best interest to be aware of your actual spending habits versus what you thought they were.  I update my 'Actual' column a minimum of every other day.  The color-coded boxes I have at the top are to track expenses with the entire amount paid, expenses that will still likely increase during the period, and expenses that have not yet been paid during the period.  This helps me to easily see where my remaining expenses for the period might be by highlighting the text in the appropriate color.  In the above example, it is the end of the period so all expenses are final - so everything is typed in black.

5. Variance.  The 'Variance' column is just a way to easily analyze your budgeted versus actual spending.  In the example above, you can see that I under-budgeted for gas and electric by about $60.  I realized that because San Diego had a chilly December, our heat and fireplace usage was fairly significant, resulting in a much higher bill than months where we don't need heat.

Read About Step 7: Make A Budget (Part II)
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