6 Easy Steps to Creating a Household Budget and Reducing Debt

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household budgetingSaving enough money to purchase a home or car, take a dream vacation, or build wealth for retirement starts with one very important factor. You must first gain an intimate understanding of how much money you have coming in and where it all goes.

The best way to get a handle on your personal finances and minimize stress is to create and follow a household budget.  Having a budget is a good idea regardless of income level. The good news is that it’s pretty easy to create one. Just follow these steps.

Step 1. Calculate Your Total Income

First, determine how much you earn from your job every month. You want to know your net income and not your gross income. Your net income is the amount you bring home in your paycheck after all the government taxes and other deductions have been made.

Then, add on income you receive from other sources to live on such as from rental property. Knowing how much you have available to save and spend is the key.

If your income isn’t always a fixed amount every month, you can take your total pay for the last 3 to 6 months and just get the average over that period of time.

Wait, where is all this going?

Okay, here’s the deal. Your objective is to get a snapshot of your savings, income and expenses as they stand today. This will help you to identify areas where you can reduce expenses and save more money. Then, after analyzing each area, you’re going to create a household budget that you’ll follow going forward.

Step 2. Tally Your Expenses

Once you know how much money you have available to live on each month, you need to grab all your bills and statements from last month. This includes credit card statements, utility bills, checkbook, etc.

In a moment you’re going to separate them into fixed and variable expenses. But don’t panic, this is super easy.

Step 3. Create a Budget Spreadsheet Template

On a spreadsheet, you’re going to create an outline for listing your savings, income, and expenses. Here’s an example of a basic layout.

Savings
1.
2.
Total

Income
1.
2.
Total

Expenses
1.
2.
Total

Step 4. Complete the Spreadsheet

Breakdown your savings amounts into categories like these:

1. Roth IRA
2. Mutual Funds
3. Money Market Fund
4. Savings Account

(Note: If you have money automatically deducted from your paycheck to go into a 401k or other retirement funds, don’t list it here. We’re only dealing with what you do with your take home paycheck and money from other sources.)

Breakdown your income amounts into categories like these:

Remember to list only sources that you use to live on.

1. Salaries/Wages
2. Capital Gains/Interest Income
3. Real Estate Rental Income
4. Pension Income
5. Tax Refund Income
6. Other Income

Breakdown your expense amounts into these 4 major categories and their subcategories discussed further down the page:

1. Essential Fixed Expenses
2. Non-essential Fixed Expenses
3. Essential Variable Expenses
4. Non-essential Variable Expenses

What are Essential and Non-Essential Expenses?

We all spend money on things that we “need” and things that we “want” right? The essential things that we “need” are those related to living, work, and personal safety. Non-essential expenditures are the nice-to-have items.

It’s important that you make an honest assessment of your personal finances and which category your expenses fall into. Also, things that are essential for one person may not be essential for another.

A perfect example of this is the widespread use of mobile phones. Some people require a mobile phone to carry out their job responsibilities, while others use them as a nice (but non-essential) way to keep in touch with friends and family. Here are some more examples:

Essential Fixed Expenses

Your essential fixed expenses are those that are the same every month. This would include the following types of payments:

– Mortgage or rent
– Automobile
– Homeowner’s Insurance
– Car Insurance
– Property Taxes
– Student Loans
– Mobile Phone

Non-Essential Fixed Expenses

– Installment Loans (e.g., furniture, etc.)
– Hired Monthly Services (e.g., lawn maintenance, etc.)
– Mobile Phone
– Subscriptions (e.g., magazines, etc.)

Essential Variable Expenses

Variable expenses are those that generally change from month to month. These would include the following types of payments:

– Electricity
– Heating
– Food
– Gasoline
– Auto repair

Non-Essential Variable Expenses

Again, variable expenses will vary from month to month.

– Entertainment
– Eating out
– New Shoes/Clothing
– Dry cleaning (e.g., shirts, etc)
– Gifts
– Video Games

Variable expenses are a little trickier to get a handle on for budgeting purposes. So when you’re completing the spreadsheet, you can use average amounts.

If you’re looking at debit or credit card statements, try to breakout the expenses into line items such as those above rather than just saying “Visa card payment”. For items or services that were small one-time purchases, you can group them under the label of “Other”. Finally, if you have payments that you make on a quarterly or semi-annual basis, just take the yearly totals and divide them by 12 months to get an average.

Step 5. Analyze Your Current Financial Situation

Once you get all the numbers down on paper and total them, you will likely immediately spot a few areas that make you groan. It will be clear that spending for those categories need to be brought under control. Be sure to highlight them.

After you spot the obvious problem areas, dig a little deeper. Start by examing the non-essential fixed and variable expenses. This is the low hanging fruit. Make a hard decision on which items have to be significantly reduced or eliminated. Highlight them and jot down a preliminary reduction percentage, e.g., 25%, 50%, 100%.

Finally, analyze the essential fixed and variable expenses. Just because they’re essential doesn’t mean you can’t save money. Maybe you can save money by refinancing your mortgage, switching homeowner’s insurance, installing energy efficient lightbulbs, buying food in bulk, etc.

Go through every item and ask yourself, “What can I do to reduce or eliminate this expense?”

Take a few days to perform this analysis. You’ll be surprised by the number of creative money-saving solutions that will pop into your head.

Step 6. Create Your Household Budget Plan

Now that you’ve made some tough choices, it’s time to create your household budget going forward. You’re going to use the same spreadsheet template. The only difference is that you’re going to be estimating or forecasting the amounts you plan to save, earn, and spend for the next year.

When doing the forecasting for your household budget, the first thing you should always do is calculate your expected income for each month. Then determine how much of it you want to save. The rule of thumb is to save at least 10%.

By deciding how much to save first, you’re almost forced to figure out how and where to reduce your expenses.

So enter your expected monthly income, savings, and expenses for each line item/category on the spreadsheet. Make sure the combined total for savings and expenses does not exceed your expected income. Now you have a well thought out monthly household budget to follow.

For each month going forward, take a blank household budget spreadsheet template and fill in the actual amounts you saved, earned, and spent. Compare your actual numbers to the budgeted estimates and note where you’re falling short. Of course, if you use software, this will make the process much easier. Here’s a software package worth considering.

Conclusion

To wrap this up, it’s vital that you have a household budget if you want to achieve your financial or wealth building goals. Start by getting a snapshot of where your current income is being saved and spent. Next make some tough decisions about which expenses you want to cut or eliminate.

Then, create a budget plan that lays out what you expect your monthly savings, income, and expense to be for the next year. Finally, each month, compare your budget to what’s actually happening. After you do this for a year, you may find that performing household budget analyses on a quarterly basis is sufficient for keeping you on track.