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This is such a fundamental tool that it has always surprised me how seldom the basics are taught. Let’s work out a monthly budget.

Here are the basics…

A budget has two sides: income and expenses. The first thing to do is figure out how much income you have in a month. Pull out the pay stubs, check direct deposit records, see how much money is coming in. Make sure you use the after tax numbers.

The next step is to figure out how much you spend each month. Did this just get more difficult? Probably so. Let’s break it down.

First make a list of basic expenses by categories: rent, utilities, groceries, loan payments, car payment, insurance, gas, etc etc… Pull out old utility bills, statements, any receipts lying around. It’s probably still pretty hazy. How much did I really spend on groceries? What about eating out? Check bank statements and credit card statements to get more information. The first time around, the picture will probably be incomplete. Just go with it, you can be a perfectionist later.

Now you should have a list that looks something like this, with totals for each category:

• Rent…
• Utilities…
• Groceries…
• Dining…
• Gas…
• Insurance…
• Savings (yes savings!)

 Now add up all the totals. This is a first pass at figuring out your expenses. How do the numbers look?

1. Which number is larger, income or expenses?
2. Do these numbers seem right to you? If your budget so far says that you should have extra money each month…do you really? Or is it disappearing somewhere?
3. If something seems wrong and there is money missing, where is it going?

Now it’s time to do some archaeology.

1.  Look for categories of spending that you didn’t think to include on your first list: coffee, snacks, lunches at work, fees, laundry, drinks, entertainment.
2. Total up the cash withdrawals from your banks statements. Can you account for where the cash went?
3. Make a separate list of expenses that only come up once a year, things like: car registration, holiday shopping, memberships, back to school expenses. Set that list aside for now.

Add up your expenses again. Do the numbers seem realistic yet? Whether they do or not, plan to spend the next month tracking where all the money goes. Pay attention to anything you pay for in cash.

Now you should have a basic picture of your monthly budget. Take a deep breath!

How does it look? Your income should be higher than your expenses, but for most people it’s probably not. So the question is, if your expenses are higher than your income, how are you getting by? Credit cards? Flailing? Stress and insanity? The next question is what to do about it?

 Like I said at the beginning, there are only two sides to a budget: income and expenses. You have to increase one or decrease the other. It usually takes longer to increase income; that is the long term goal. In the short term, here’s how to deal with expenses…

Divide them up into two categories: fixed and variable. Fixed expenses are things that you can’t easily change that are the same month to month. Rent is the big one. Utilities, groceries, memberships, car payments, insurance…these are all fixed expenses. Mostly, we’ll get to that later. Variable expenses are things that you can control, like eating out, entertainment, clothes shopping, etc.

Total up your fixed expenses and total up your variable expenses. If your budget didn’t balance to start with, you need to reduce your variable expenses. Now it becomes psychological, and that is the whole project.

Let’s go back to fixed expenses. If you can’t balance the budget by reducing variable expenses, you have to look harder at these categories. Let’s take utilities, for example. I put this in the category of fixed expenses, along with groceries. Formal definitions would put these in the variable category. I deal with them as fixed expenses because it works better in a household budget, and I’m not a CFO. The truth is they have both a fixed and a variable component. You need to have electricity and water, and you need to eat. The minimum amount you can possibly spend on these is more or less fixed. Anything above that is variable. If you can’t balance your budget by reducing variable expenses alone, then you have to look at these categories and find ways to save.

What if the budget still doesn’t balance? Now we start getting creative. The truth is that fixed expenses are not really fixed. Rent is fixed, right? Well…yes. Memberships? Netflix? Cable? All fixed. Car payment? Ditto. And if the budget still doesn’t balance? It’s time for some restructuring. You could ask for a raise, get a second job, get a new job, or cancel the memberships and find a cheaper apartment. None of these things are pleasant…unless you land a new job that you love and it pays more! But the sooner the budget balances, the sooner the stress will go away. I promise.

I left a couple things hanging for another post…annual expenses, seasonal variations in utlitities. What if your income isn’t the same from month to month? And the most important part of a budget…variance analysis…how to figure out whether your budget is working for you. More on these coming next…