A budget is a powerful tool that will help you improve your finances by helping you to plan how you’ll spend your money each month. Creating a budget is an essential first step for anyone who wishes to gain a better understanding of where their money goes and how to improve their financial situation.
In a nutshell, a budget is an overview of your income versus your expenses. It’s a plan for how you’ll spend your money each month and how much you expect to have left over at the end. In this way, a budget can help you find ways to change your spending habits to achieve your money goals – whether that’s increasing your savings or pension contributions or paying down debt.
There are lots of ways to go about creating a budget. The important thing is to understand the key elements to the budgeting process. Once you’ve mastered the basic techniques, you’ll be able to apply them to your own situation, to help you achieve your financial goals.
How To Come Up With A Budget Plan
A good place to start is looking at how you’re spending your money at the moment. The first step is to list all of your sources of income on a monthly basis, after tax. While it’s possible to budget on a weekly or bi-weekly basis, it’s often easier to start with a monthly view, given that many bills only occur once a month, and then break it down into smaller chunks after that.
Step 1: List Your Income
If you’re employed with regular hours and no side hustles, this is fairly straightforward as you can find the information by looking at your bank account or payslip. For freelancers, it’s more complicated due to potentially irregular work and pay patterns. For ease, start with your average income over the last 6 to 12 months if you’re a freelancer, depending on how seasonal your work is.
Step 2: Bills, Bills, Bills
Next, list all of your regularly occurring expenses each month, by category – for example, rent/ mortgage payment, utility bills, phone bills, transport, food, fitness and other subscriptions. Don’t forget any other categories that may be relevant to you, e.g. pet supplies or private health insurance. If you’re not sure how much you spend on each category – or even which categories to use – go through your last three months of bank and credit card statements. Many banking apps automatically break down your expenditure by category, which can be helpful too.
The next step is to subtract your income from your expenses to get a view of how healthy your monthly finances are at the moment. Any money left over at the end of each month can be used for savings or to pay down debt. If your income is higher than your expenses, you can breathe a sigh of relief!
Step 3: Rinse and Repeat
If you haven’t got as much money left as you’d like, then you can go back to each category and see if you are able to cut some of your expenses. If you’re consistently spending more than you earn, then you’re likely to be living beyond your means, and more drastic action will need to be taken.
Once you’ve worked out how much you are comfortable spending on each category and understand what that means for how much you’re able to save, it’s a good idea to check if you can make any improvements to reach your financial goals. Look critically at your budget and ask yourself questions like:
- Am I saving enough?
- Do I spend more than I need to on certain things like eating out?
- Am I spending intentionally?
For example, if you have a goal of saving for a house deposit over a specific time frame, you need to work out how much you need to set aside each month to reach your goal.
This may mean cutting back on spending in certain areas or finding ways to cut little everyday expenditure, such as changing utility or phone providers to get cheaper deals, or forgoing that daily £3 coffee.
Saving £3 each day in the workweek can add up to £15 a week, or over £60 a month, or £780 a year.
How Much Should I Spend On What?
There are lots of ‘budgeting rules’ out there. The important thing is not which rule you follow, but that the amount you spend make sense relative to what you value and want to achieve.
This part of the exercise is highly personal and should not involve others’ judgment – instead, ask yourself if what you spend makes sense to you and is in line with what you value. For example, two people on the same income may spend wildly different amounts on rent, because one person lives in a flat share while the other one rents a one bedroom flat to themselves.
There is no right or wrong – assuming it’s affordable for them – but of course it has budgeting implications. The person spending more on rent may forego a holiday with friends due to the higher expense on rent, or just decide to save less of their income.
Nevertheless, some people find it useful to have rules for spending. One such rule is ‘paying yourself first’. This is less about how much to spend, but rather how you prioritise spending.
Read More: How Much Should You Spend On A Car In The UK?
Using this method, you first decide how much you want to set aside for savings on a monthly basis, and then only allow yourself to spend what’s left after that.
This works well if you base your savings target on disposable income after all your necessities are paid for – things which you wouldn’t want or be able to cut down on to be able to save more.
For example, if you earn £2,000 a month after tax, spend £700 on rent and bills, £150 on transport and £400 on food and other necessities. Your disposable income after these items is £750, of which you might decide to save £500, with £250 left to cover things such as clothes, eating out or holidays.
Meanwhile, others find budgeting rules that dictate how big a % to spend on different categories useful.
For example, live on less than 90% of your income and save 10%, or the 50/30/20 rule of spending – spend 50% on rent and bills, 30% on everything else and 20% on saving including pensions. Another rule of thumb which you might see is to avoid spending more than 1/3 of your income on your rent or mortgage, while yet another is to aim for pension contributions of a percentage of your income equal to half your age (e.g. 15% if you’re 30, etc).
Read More: How Much Should You Spend On Rent & Utilities In The UK?
Budgeting Tools To Help Manage Your Money
There are many tools out there to help you keep track of your budget and your actual spending each month against it.
While spreadsheets are an option, the easiest way to keep track of your budget each month is to use a budgeting app. The important thing is to capture what you’re spending on a daily basis and ensure it gets allocated to a category that you’ve budgeted for.
Make sure to capture spending in cash as well as across all your accounts including your credit card. That way, you can see how well you’re doing at sticking to your budget throughout the month and make tweaks if necessary.
A 5 Step Checklist To A Successful Budget Plan
- List all of your income after tax on a monthly basis
- List of all your monthly expenses – look at past statements if you aren’t sure how much you spend on things like food or energy bills
- Work out how much you want to save each month and compare it to where you are now
- Look at your spending critically and work out what you are comfortable with spending on each category
- Track your spending as the month goes on and compare it to your budget.
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