Step 4 - Determining Income & Creating a Budget

Does the word budget scare you?  


A common reaction to the word budget is the equivalent of going on an extreme diet and robbing yourself of anything pleasurable for the foreseeable future.  


I promise you, this is not the purpose of a budget.  As Dave Ramsey says, a budget is telling your money where to go rather than wondering where it went.


In order to slay your debt, you need to create a budget.





To begin, you need to determine your income.  For some, this will be easy - especially if you have a regular paycheque.  Take the NET amount you receive - calculate the NET amount by taking your total earnings for one year and subtracting deductions (like taxes, pension dues, EI, CPP, etc.) - divide this number by 12.  This is the amount of money you have to work with to draft your budget.  As an example, my GROSS or TOTAL income might be $60,000 for one year, but once I might pay pension dues, then income tax is deducted, along with EI, etc. I'm left with $38,000.  I would take $38,000 and divide by 12.  This means my monthly NET income would be $3,166.00

For those with irregular income, this part of money management can be tricky.  I will write posts directly related to this topic, but for now, use your prior few years as an average gauge.  If you're new to your job and don't know what you'll earn, you might need to ask a mentor or manager to give you a sense of what you might expect to earn.  Even if your money isn't regular, you need to determine roughly how much NET income you have if you divide your annual net income by 12 - this is how much you'll have to draft your budget.



Remember the expenses you wrote down in Step 3?  You need them now to configure your budget. Keep in mind that your expenses need to be less than or equal to your monthly net income.  If your expenses are higher than your monthly net income - you'll need to cut back (Step 3) or earn more (Step 6).  If you'd like a template to work with, download my FREE budget creation guide.  

Otherwise, a spreadsheet, blank piece of paper, or any of the online budgeting programs will do.  My favorite and EVER life changing budget software recommendation is YNAB or - you receive an automatic 34 day FREE trial - go ahead, give it a shot!

In drafting your budget, we'll explore three types of expenses - fixed, variable, and emergency/savings.



Fixed Expenses

Fixed Expenses are those which are the same amount each time you pay them.  Generally speaking, you know exactly how much they will be, and how often you'll need to pay them.  For now, deal with expenses that are payable within the month - they might be paid weekly, biweekly, or monthly.  We'll deal with less frequent expenses later.  Fixed expenses are the easiest to deal with as both the amount and date are known.  Examples might include rent, insurance, subscriptions, loan payments, leases, etc.

An example is provided below.

Variable Expenses

Now, write down expenses that have no set amount, some of which will have fixed due dates, while others won't.  Examples of those with fixed due dates are your cell phone, loan and credit card interest and electricity - you generally know the date they're due, but the amount payable can change.  Examples of those with no fixed due date AND no fixed amount include things like gas, groceries, gifts, etc - these are inevitable, but you don't necessarily know when you'll incur the expense or the exact amount due.  Include all expenses that you'll actually pay within the month.  Again, we'll deal with less regular expenses separately.

Most importantly, choose a minimum amount you're going to put towards any debt - this will be a number you will never reduce - only increase at moments you have extra money, or when you can reduce expenses and redirect funds towards this debt.

To come up with a budgeted amount for these more unique expenses, look through your bank statements over the past three months.  Add up things like gas and groceries - you should be able to come up with an average to work with.

Similar to Fixed Expenses, add the Variable Expenses to your Budget.

Emergency / Savings

This part of the budget is unique - it will consist of both variable and fixed expenses.  To start, we'll begin with fixed emergency/savings categories - think of property taxes that you pay once per year.  Imagine this cost is $1,200 per year, so to avoid the devastation of paying the $1,200 at once, you'd be best to budget $100 per month so when the bill rolls around you have the money saved.  

Consider any other fixed but less-than-regular expenses - they're roughly the same amount, but not necessary as regular as once per month.  Car insurance, home insurance, fees and dues can be examples of this.  Take the full amount payable, divided by the number of months until the next time you'll need to pay this bill.

So imagine my car insurance was $1,200, but I haven't saved anything yet.  The bill is due in 6 months.  Take $1,200 divided by the six months you have left to save - this results in $200 per month.  So you'd budget $200 per month in this case.

Other emergency / savings variable expenses can include vacations or car and home repair.  Car repairs are a great example of an expense that catches people off-guard - which is interesting as most of us know that inevitably our car will need an oil change or repair of some kind.  For this type of expense, give thought to how much you've spent over the course of one year - maybe you have two oil changes a year and some maintenance.  Perhaps you end up spending $700 per year overall - in this case, budget $60 per month.

Here's the unique aspect to this part of your budget.  You're best to move the total of the budgeted money - for this section only - into an emergency / savings bank account.

Picture this - for car repair you budget $60 per month, for car insurance you budget $200 per month - so at the month end you would transfer $260 into your emergency/savings account.  Then you'd do the same for the next month, and so on.  Eventually when the bills roll around, if you don't have the entire amount saved, you'd certainly experience less financial pain as you'd have a partial buffer saved.  And most importantly - much less need to lean on your credit.

If you haven't heard me say this before, YNAB is the best software out there (in my humble opinion) to manage this for you.  Again, there's a learning curve, but it streamlines the entire process.

Finalizing your budget

Now, you should have your fixed, variable, and emergency/savings expenses approximated.  You now need to total all your budgeted amounts.  Your total needs to be equal to or less than your monthly NET income.  The best case scenario is a budget total that is less than your monthly income - the more money you have left over, the more you can throw towards your debt category.

TIP: It's good practice to continually revisit your expenses.  As services shift and change better options may become available for you.  Considerations include different cell providers, better insurance rates, etc.

Now that you're 'budget ready' - you need to start tracking your spending.  On to Step 5.