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Budgeting Series, Part III: How to Make a Budget

Income - OutgoingsYou’ve come to this post for a reason: to get control of your money. You are tired of making excuses and are ready to make a giant step towards being financially healthy. I applaud your courage because the journey you are about to embark on is not for the faint of heart.

The first few real budgets my wife and I put together were a disaster. We had some long “discussions” about how much money should go in each category and we were always changing numbers in the middle of the month for things we had not anticipated. I thought we would never get it right. But we stayed the course with it, through the trial and error, and eventually we figured it out.

The best part is – now that we have figured it out – doing a monthly budget is pretty easy. So there is hope.

In this post, I’m going to walk through the steps of how to set up a budget. By the time I’m done, you will have the basics to begin setting up an effective budget.

But before I get to the nuts and bolts, there are a few ground rules about budgeting. A budget’s effectiveness will be lessened if these principles are not followed:

Budgeting Rule #1: A new budget must be created for every month, before the month begins.

We used to do a budget where we would plug a number into a budget category for the year and then divide by twelve. It was a disaster because we soon realized every month of the calendar year is different. There is shopping for spring clothing in April, purchasing back to school supplies in August and buying Christmas presents in December. Every month needs it’s own separate budget.

Budgeting Rule #2: It should be a zero based budget.

This means every dollar of income, no matter where we plan for it to go, has a category attached to it. Even the money we plan to save. The goal of budgeting should not be to have $400 left over at the end of the month. Every dollar needs to be specifically spent (assigned) on paper so that the income minus the outgo equals zero.

Budgeting Rule #3: The budget can be changed during the month, but it has to remain a zero based budget.

If there is an unexpected expense during the month, money can be moved around within the budget categories to account for that expense. (An example would be moving money from the clothing budget to pay for car repairs.) What cannot happen is the use of credit cards (going into debt) to cover the extra expense. That’s cheating on the budget. More was spent in that particular category and there was no accounting for where the money was going to come from.

Budgeting Rule #4: Find someone to give feedback on your budget.

If you are married, this will be easy – you will work on it with your spouse. It is an absolute must for the married couple to work on this together and be in agreement on the monthly budget numbers. It won’t be an easy process, especially as you begin, but in the long run working together and sharing the burden will greatly enhance the marriage relationship and the effectiveness of the budget.

If you are single, this will be more challenging. Find someone you trust to be an accountability partner. It should be someone who is not afraid to tell you “No” if you are doing something silly in your budget.

Set on the budgeting rules? All right then. Let’s make a budget.

Steps to Setting Up An Effective Budget

Step #1: Income

The easiest step will be figuring out how much money is coming in each month. In addition to your job, be sure to include any type of regular income you might be receiving such as child support payments, monthly dividends from investments, rental income or cash gifts from relatives. Total the sum of all these categories to arrive at the total monthly income number.

Step #2: Expenses

Expenses are more of a challenge to calculate simply because not all expenses happen each and every month. (That’s one reason it is important to save ahead of time for expenditures you know will be coming.) So it may take three to four months of tracking expenses before you really start to get the budget right. Don’t worry about that…it’s normal for everyone.

Expenses should be broken down into categories. These will vary depending on the particular situation. Here are some basic suggestions with what might go into each category:

Charitable Giving – money given to one’s church or other charitable organization

Saving – money set aside into a savings, retirement, kids college fund and other investments

Housing – mortgages, taxes, homeowners insurance, maintenance or repairs

Utilities – services for gas, electric, water, cable, trash, and the Internet go here. Oh…don’t forget the cell phone.

Transportation – all car payments, gas, car insurance, car repairs and maintenance

Food – groceries and restaurants


Medical or Health – health insurance, doctor visits, and medications

Entertainment – vacations, day trips, magazine and Netflix subscriptions, and iTunes downloads

Debts – all credit cards, student loans and personal loans here

Other – a catch-all category for items that don’t fit neatly into the others. This would include things like life insurance, personal care items, the kids school supplies or tuition, and gifts.

The biggest challenge of step 2 is to not leaving anything out. If that happens (and it will) make a note of it and correct it in the next month’s budget.

Step #3: Make it zero-based

In step 3, double check to make sure the income minus all the expenditures equals zero (income – expenditures = zero). If it doesn’t, go back to step 2 and fiddle with the numbers a bit. It’s really important that every dollar earned is assigned a category.

Step #4: Live it out

This is the most challenging step. You actually have to live out in real life this monthly budget that was just created. It makes no sense to create a budget on paper and then choose not to follow it. Yet people do this all the time.

A word of warning is needed here. As soon as you get fired up and are beginning to see progress, a particular person will choose to cross your path. His name is Murphy and he manifests himself in many ways….a son’s broken arm…a flat tire…a leaky sink….a faulty air conditioner…busted eyeglasses.

It can be very discouraging when everything is planned out perfectly in the budget and an emergency happens. The typical response is to put the expense of the emergency on a credit card. But remember, that violates Budgeting Rule #3.

This is when an emergency savings fund keeps us from busting our monthly budget. When a crisis presents itself, you can manage through it by adjusting the budget and drawing from the emergency savings account to pay for the extra expense.

Step #5: End of the month comparison

At the end of the month, do the calculations of each expense category and compare it with what was actually budgeted. (Ideally this is taking place periodically through the course of the month as well.) See if any categories were way off and make adjustments for the next month’s budget where applicable.

Step #6: Evaluate the category percentages

This step is not as critical as steps 1-5. However, at some point within the first three months the budget categories should be evaluated to see the percentage of money going into each one per month. This will allow adjustments to be made in those categories where too much or too little is being spent.

To calculate percentage, take the total income earned in step #1 and multiply by the desired percentage. For example, if you earned $3,500 per month and wanted to save 8% the mathematical formula would look like this:

3,500 x .08 = 280

So what percentage should be in each category? Glad you asked. Here are the recommendations from Dave Ramsey’s FPU class that we have chosen to use as a guide in our house:

Charitable Giving       10 – 15%

Saving                             5 – 10%

Housing                       25 – 35%

Utilities                          5 – 10%

Transportation            10 – 15%

Food                                5 – 15%

Clothing                           2 – 7%

Medical/Health            5 – 10%

Entertainment              5 – 10%

Debts                              5 – 10%

Other                              5 – 10%

These numbers will vary depending on your income level and family dynamics. So don’t get caught up in being a little over or a little under each percentage. Remember this is just a guide to give you direction and feedback as to where the money is really going.

The neat thing about tracking spending is that a history soon develops. I have multiple years of budgets I can go back and reference. In that history, I can see how income and expenses have changed over time. But most importantly, I can see progress. And that’s an awesome boost of confidence to know that I’m winning with my money.

Some Final Thoughts.

When my wife and I started putting together monthly budgets, we noticed a remarkable thing happen. We got a raise. Well, not literally but it felt like it. We had been neglecting our finances for so long we really didn’t know where our money was going.

After we got serious about it, our money seemed to be going further each month. We realized, when managed properly, it could be used for many more things. In that way, it seemed like we had given ourselves a raise. That was a great side benefit of budgeting we had not anticipated.

Feel free to shoot any questions my way in the comments section below or through the use of the Contact Form. I’d love to hear a success story as you gain control of your money. Happy budgeting!

Remember those first few budgets? What was the biggest challenged you faced early on in the budget process? 

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  1. I found a system very like this at YNAB and since have been reading other articles.

    You are doing the same thing I am. The budget has been a miracle for my finances. I got a HUGE raise when I started budgeting.

    The percentages you listed are very helpful. I wanted to know what “average” was and wanted something I could aim for. Not many articles include anything for percentages. Like many, my numbers are very different from the average and it’s what I work toward.

    Thanks for the very informative article.

  2. I am paid once a month, and my spouse is paid every other week. On paper, we should have ample money to pay all of our bills, plus have $$ left over. We have been in the habit of paying all of our bills that we can the first of the month, and then the others with the remaining pay periods. However, we always are completely out of money between pay periods and sometimes fall behind. We don’t know if we need to pay our bills on a different timeline, or what we need to do. We set up a budget a few months ago, but, again, we always run out of $$ between pay periods. Thoughts?

    • Nancy,

      Sounds to me like it’s a cash flow problem (i.e. you have money coming in at certain times and bills to pay at certain times and those aren’t lining up correctly yet). If you have enough on paper to pay the bills with $$ left over then you should have enough. It might just take some adjustment to get certain bills paid at the right time. Also, check your budget categories to see if you are overspending in a particular category. One issue many have with budgeting is setting one up but not really sticking to it.

  3. john cartner says

    During the real estate boom, I made $150,000/year, $250,000/year, and
    towards the end of 2005, $650,000/year as a mortgage broker. However,
    when business dried up I suddenly found myself without a job and a
    family of 7. Somehow my family had zero in savings, zero equity, and
    didn’t own a home. The Budget Saviour showed me how I was wasting away
    my money on things that didn’t matter . It’s taken a lot of discipline
    but now my family is back on track, saving approximately 15% of our
    income monthly and getting ready to put a down payment on our dream

  4. Love the “How To” series. The “how to budget” lesson hits home with me. It took me a long time to finally make a monthly budget and when I did shine a light on it, I was surprised on 1. How much I was spending on things like eating out (a complete waste of money) and 2. How easy it was to spend less once I knew how much I was actually spending on stuff.

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