How To Make A Budget That Works: A Step-by-Step Guide (Updated 2019)

One of the first things you learn in personal finance is how to make a budget. That’s because a personal budget it’s a powerful forcing mechanism save money by getting your organized and focused.

Establishing a solid foundation and understanding of what your money is doing, will free up cash flow for paying down debt and investing, as well as multiple other reasons why creating a budget is a good idea.

We’re going to begin learning how to make a budget by utilizing a simple financial planning tool called the zero-based budget.

What’s a zero-based budget?

Simply put, it’s a proactive monthly budget that you create prior to the start of the month, where you assign a job to each dollar you have coming in until it equals zero.  

Other budgeting techniques tend to function more as after-the-fact shaming tools, enabling you to view all the damage you did during the previous month, at which point it’s too late to do anything about it.

The concept of zero-based budgeting has been around for years and is structured around this simple equation (monthly income – monthly expenses =  cash flow).  Besides simplicity, there are lots of good reasons that personal finance professionals recommend it.

  • A budget proactively highlights spending issues before they arise
  • It forces organization and personal control
  • Reduces the monthly stress brought on by juggling bills by giving you a game plan in advance

How to prepare to create your first budget

how to make a budget

This will go way smoother with a just a little bit of prep. Here’s what you’ll need:

  • Paper and pencil
  • Calculator
  • Your last few pay statements or bank statements
  • Any bills you’ve received for the upcoming month
  • 30 minutes
  • Whiteboard and dry erase marker (optional)

The reason for the paper and pencil is that you should really do this by hand the first time since you’ll likely be scratching things out and rewriting it. Once you have it all put together, you can put it any format you like.

Whiteboard with list

How to make a monthly budget

First, write the name of the upcoming month in the top right-hand corner of your paper, and “Income” at the top left.

What money is coming in?

Underneath that, list what you know you will get paid in the upcoming month, and the day you will get paid. Be sure to include things like a child or spousal support.

Quick Note: How to Treat Irregular Income

For irregular income like commission-based or hourly, include what you typically receive on average. During the month, we will treat anything additional as “extra” cash flow to be used as it comes in.

What money is going out?

Below your income, write “expenses.” Here, we will list your monthly expenses, using the following three categories.

  1. Must Haves: housing, groceries, utilities, phone, childcare, insurance, medical, etc.
  2. Debt Payments: credit card debt, car loans, personal loans, student loans, etc.
  3. Nice To Haves: eating out, gym, cable, Netflix, subscription services (i.e. magazines, etc.)

Identify your must-haves

First, list your “Must-Haves.” Be honest with yourself here. If it’s not truly a must-have, we’ll still include it–just not in this section. Next, to each item write the amount due (or average amount spent in previous months) and the due date where relevant.  

Note: For items like groceries, where it’s not one set of fixed expenses for the month, put down your best guess of what you’re spending. This will be a living, breathing document that you will update all the time, so eventually, you will get dialed into how much you are actually spending.

List of expenses

Total Must-Have Expense = $3350

Your debt payments

Next, create your “Debt” category. List them by name, payment amount, due date AND outstanding balance.  This category is inclusive of credit cards, personal loans, car loans, medical loans, and other personal debt.  In the case of a home mortgage, I recommend you include that as a “must-have”.

List of debt payments

Total Debt Payments = $625

And your nice to have

Now list your “Nice to Haves” in the same fashion as above (i.e. item, amount due, due date).

Nice to haves are things you enjoy but could do without. This list is bigger than you think, since you may consider a lot of things to be must-haves that really aren’t.  

For example, You need clothes, but odds are you already have some, so buying new clothes would not be a “Must Have” unless it’s something like a new winter coat for your kid or a suit for a job interview. Other common nice to haves include Netflix, the gym, cable, restaurants, movies, piano lessons, etc. 

Putting it all together

If you’ve been following along, you should now have a prioritized, and organized list of all your income and expenses for the month, like pictured below.

My finished budget…

Understanding your cash flow

Note: This part is pretty easy math, but having a calculator nearby won’t hurt.

  • First: Add up all your income and write it down as “Total Monthly Income.”
  • Second: Add up all your expense by each of the three groups, write them down, and then add up those three totals. Write this down as “Total Monthly Expenses.”
  • Third: Subtract your “Total Monthly Expenses” from your “Total Monthly Income.” Take that number, positive or negative, and write it down as “Total Monthly Cash Flow.”

Want To Learn More About Cash Flow?

For a few more examples check out this post on how to calculate and manage cash flow which also includes 7 tips for increasing cash flow.  

Shouldn’t it equal zero?

Yes!!  That is what makes this number so important.  Assuming that you have a positive number for your cash flow…all of the available cash flow is allocated against one of the following items depending on what phase you are in your financial transformation. 

  1. Pay down debt
  2. Build up your emergency savings
  3. Invest for your future

Stop! Now review and refine

Take a deep breath…and another look. Now that you have the full picture in front of you, you may not be happy with how you’ve classified some things.  At this point, everyone’s budget will ultimately fall into one of two categories; positive cash flow and negative cash flow.  

Regardless of which category yours falls in, the strategies behind the tool won’t change, just how forcefully you apply them. In either case, you need to take a critical look at your income and expenses to identify where the highest points of leverage are so you can create some more margin/breathing room within it.  

Where can you move the needle?

Do you need all the nice to haves?

These are your quickest points of leverage since you have already identified them as expendable.  Cut deep and stop spending money where it’s not critical.  Every dollar saved in this category is a dollar directly into your cash flow.  Think about these as your gas pedal.  Hit it!

Are you sure it’s a must-have?

Challenge your assumptions on what is a must-have.   If childcare costs exceed income, one of the parents may be better off staying at home.  If your house payment is more then 25% of your take-home pay, you will struggle if you don’t lower it. Groceries are typically a huge % of this category, so aim your sights on lowering that amount.

Can you increase your income?  Even for a short time?

If your income is too low,  making adjustments to your expenses are only going to provide you incremental results. Can you do anything to increase your income, even if it’s for a short time?  Second Job? Overtime? Sell stuff on eBay or have a yard sale?  

Hit the debt, hard!

Paying interest on the debt is painful, and the higher the interest rates the worst it is.   Truth is, the only sure-fire way to get rid of pain is to get rid of the debt.  You can focus on paying it off, or if you have a secured debt with an asset behind it, like a car. Sell it and buy a piece of junk until you are out of debt.  

Bankruptcy is not always an option

You’ll need to think long and hard about before considering bankruptcy.  There are multiple difference “chapters” you’ll need to consider, which different implications on what is covered.  It most cases things like government-backed student loans, taxes, alimony, are not covered.  If those are places where you carry the most debt, you may not end up any further ahead.  

Put your budget where you can see it!

Once you’re satisfied with your plan, you’ll need to put it someplace visible, where you’ll see it every single day. I put mine on a whiteboard above my desk. As you go through the month, you now have a view of what money is coming in and when, where that money needs to go, when it needs to go, and how it’s prioritized in case you need to make tradeoffs to cover unexpected expenses. 

A few days before the beginning of every month, you’ll need to redo this budget to reflect the upcoming month’s paydays and expenses. Remember, it’s a proactive tool, not a report!

If you’re struggling to stick with your budget, try using a something like the cash envelope system, where you put your budgeted cash into categorized envelopes used for tracking spending. 

My finished budget…

Wrapping up

Let me go ahead and break it to you–you’re going to mess this up in the beginning. But that’s alright, as long as you learn from it and move on.  Just don’t get frustrated and give up.  Clearly identify what’s motivating you.  

You’re developing a brand new muscle, so it will take time for it to gain strength. Give it the reps it needs to get there.  Even though you know how to make a budget, keeping at it takes determination.

If you do stick with it, in a few months you will have a predictable way to manage your finances. This creates the right foundation to enable you to tackle even bigger goals, like getting out of debt and investing for the future.  

In the comments below, please share any tips or tricks you learned to help you stick to your budget!

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