Jasmine Birtles
Your money-making expert. Financial journalist, TV and radio personality.
Budgeting Basics: Definitions and Early Steps
Moneymagpie Team
24th Sep 2024
Finances can be complicated and scary for many people. Many people hate math and try to avoid it entirely either by spending as little as they can or overspending frequently. Both of these strategies are stressful and unproductive. The best way to handle your finances is to set up a budget.
To help improve your financial situation and standing, this article will explain the various parts of a budget and provide you with enough information to start thinking about how to set up your own.
You’ll know your budget is working as intended when you are making progress toward or are meeting your financial goals, have extra cash to spend for treats and gifts at the best of times, and don’t have to panic as you are exploring exceptions to NYC no-fault rules in the worst of times.
- Defining Budget
- Calculate Earnings and Expenses
- Determine Priorities
- Understanding the Importance of Savings
- Select a Budgeting Strategy
- Staying on Top of Your Money
Defining Budget
The term “budget” is thrown around frequently. To make sure the rest of this article makes sense, we’ll clearly define it.
A budget in this instance is a plan describing how income is spent or saved. Budget plans calculate how much money someone brings in, how much they need to spend, what is set aside for savings, and dividing out the rest as appropriate.
Setting up and following a budget has a wide range of benefits. Setting up a budget will require you to look closely at both your income and expenses. The ideal situation is to have as much coming in with as few expenses as possible.
For example, you make good money, but discover you’re spending too much on bills. Some of them, such as the water or electric bills, can’t be eliminated. Streaming service subscriptions and other entertainment-related expenses may be nice, but are also non-essential.
You may have to cut loose a subscription or two to meet your financial goals. When done properly, a budget gives a sense of security as you know you have money available to cover emergency expenses should they arise.
Calculate Earnings and Expenses
It’s been made pretty clear so far that understanding your income and expenses are vital to creating and following a budget, but how do you do that? The first step is to gather financial documents. Multiple months worth of debit and credit card statements are required to nail down regular expenses and weed out irregular ones. Three or four months should be enough to paint this picture.
You’ll also need to calculate your income. Some people do this by figuring out their pre-tax earnings, while others focus on their take-home pay. Which you choose to do is up to you, though many resources recommend focusing on take-home pay as this is the money you’ll be able to spend or save as desired.
Income may refer to money earned at your main job, brought in by side gigs, or gotten through other means such as social security, disability or alimony payments. If you receive and can spend it, it needs to be considered income for the sake of your budget.
Determine Priorities
Once you understand your income and have a list of your expenditures handy, it’s time to consider which debts you need to pay off first. While the decision is ultimately up to you and make change as your circumstances do, there are some factors to consider to make this decision easier.
First, determine if you are behind on debt payments and what the consequences of that are. It’s wise to catch up on delinquent payments first as these tend to cause damage to your credit score and can sometimes come with other negative consequences. Not paying on these debts for too long may result in them entering collections, which is when a debt is handed to an agency whose job is to collect the money owed. Avoiding this is ideal.
You then need to decide which debts you’re caught up on, their types and their interest rates. Some types of debt, such as tax debt, need to be prioritized to prevent negative consequences while other types, such as mortgages, can be slowly paid off over time.
Consider paying off high interstate rate debt next, as these payments can be more expensive and can become difficult to pay. Debts that you’re caught up on should be kept that way when possible until you’re able to pay them off.
Understanding the Importance of Savings
Once everything has been calculated and you’ve determined when each debt will be prioritized, you need to consider how much money you have left so you can determine how much will enter as a savings account.
A savings account is vital for a variety of reasons. Many consider it their emergency fund. Others use it so set money aside for a large purchase or investment, such as a new car or house.
You may have to dip into the savings account occasionally, but there’s no need to panic. Just don’t make it a habit and continue contributing consistent payments to it to build it back up and make your safety net even more reliable.
Select a Budgeting Strategy
You now have a list of your expenses in front of you, you know which you’d like to prioritize, you understand your income and you know why a savings account is so important. Now you just have to create a plan that fulfills all of the goals you’ve set for yourself. Luckily, there are a few pre-existing strategies to evaluate and choose from.
One of the most popular budget strategies is 50/30/20. Each number is a percentage of how much income you’ll spend and where it goes. The 50% refers to setting 50% of your income aside for your needs, 20% is put into savings and the remaining 30% is for you to use for your wants—this works for many people but not for everyone, so adjust as needed based on your own situation.
If you’re an impulsive spender, you may want to consider the 0 based budget. This is when you allocate every cent you earn to specific expenses, including savings, and leaving your bank account with $0 left. This method can be risky, though. Don’t worry if neither of these strategies sound appealing; there are many more to consider.
Staying on Top of Your Money
Hopefully, you now understand budgeting a little bit better and feel more confident about how to create a budget that works for you. Don’t be afraid to do more research. There are plenty of budgeting guides and calculators to turn this intimidating process into a nearly stress-free cakewalk.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.
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