If you’re just stopping by for the first time, this is the fourth class in a series of classes over the next few months which will culminate in the development of a complete financial plan. Stop by the orientation class HERE first for class orientation/overviews and HERE for more information about the website.
Class Objectives: To understand how to create a traditional or zero-based budget and cash flow statement.
Prerequisites: PF101: Intro to Personal Finance & Goals and PF103: Tracking Your Expenses
Handout: Seasonal & Holiday Budget Expenses
Assignment: Budget & Cash Flow spreadsheet for one-income family in Excel| Google Docs
Budget & Cash Flow spreadsheet for two-income family in Excel | Google Docs
AND/OR budgeting software such as Mint or YNAB
If you’ve been following along with each class, then you’ve already:
- Set short-term, mid-term and long-term financial goals (PF101)
- Faced the truth of exactly where you’re currently at financially by creating a net worth statement (PF102), and
- Started tracking your expenses so that you can see exactly where your money is going each month (PF103)
This class is basically just an extension of tracking your expenses. Now that you have tracked where your money is going for at least one month, there are likely certain categories where you’ve discovered that you’re spending more than you’d like. A budget is simply a plan of where to spend your money in the future. It’s not a money diet, it’s more like making a menu of meals that you plan to eat during the week, perhaps with some dessert in the menu as well. If you generally spend $300/month on shoes (I would too, but it’s not in my budget unfortunately), then go ahead and put that in your budget. The most important thing about your budget is that your expenses don’t exceed your income. If they do, you will have to cut back on those shoes until you can actually afford to buy them. If they don’t, then you’re good to go…to go shoe shopping that is!
The second part of this class is creating an annual cash flow statement. Your cash flow statement is going to look exactly like your annual budget, just with actual numbers from the month instead of planned numbers. You need to keep tracking your expenses to complete the cash flow statement, but this gets easier, especially if you set up your categories in a software program linked to your accounts.
Note: Although essentially all other monthly budgeting spreadsheets, printables and even finance software you use will start with take-home income (salary or wage income adjusted for payroll and withholding taxes and other payroll deductions), I want you to start with gross income as shown in the spreadsheets below and track all those deductions as expenses just like any other expense you include in your budget. Although many of these deductions are not necessarily voluntary (such as FICA taxes), many can be adjusted in the amount (federal and state withholding taxes, retirement contributions). Don’t ignore these expenses in your budget as they are often 25% or more of your gross income!
TRADITIONAL VS. ZERO-BASED BUDGETS
A traditional budget starts with income, then subtracts expenses to arrive at an excess or shortage amount. For example, if your income is $5,000 a month and your total expenses are $4,500, you have an extra $500 per month at the bottom of your budget.
In contrast, a zero-based budget requires you to categorize all your income and expense amounts until you reach a total of zero. This essentially makes you give each and every dollar that you earn a purpose. For the previous example, you would have to assign the $500 to other categories, such as paying off an additional $300 that month towards debt and $200 towards an emergency fund. If instead your expenses exceed your income, you would have to lower your expenses until they were in line with your income for that month. I highly recommend using a zero-based budget so that your “extra” dollars get put toward your goals and not just spent because you have the funds.
The spreadsheet shown below (part of your homework assignment) can be used whether you decide to go with a traditional or zero-based budget. If you’ve decided to go with a zero-based budget (good choice friend!), then you should allocate all your funds to different categories until the amount at the very end labeled “Total Excess (Shortage) Per Month” is zero. If you’re already using a software program to track your expenses, that’s great! Go ahead and use that as long as it shows both budget and actual amounts. If it doesn’t, I would suggest transferring the total monthly income and expenses into this spreadsheet so that you can get a clear comparison of your month. If you’re following along with each class, I really suggest using this spreadsheet for the first little while regardless of your current budgeting system as there will be many future classes and posts that will refer to and use this spreadsheet. A few other spreadsheet resources I’ll be offering will allow you to directly copy and paste numbers from this budget.
ANNUAL & MONTHLY BUDGET & CASH FLOW STATEMENTS
I’m a nerd, so I create a budget in January for the entire year. If you aren’t ready for that, start with one month (the current or next month) and go from there. Budgeting an entire year would be especially overwhelming if you’re budgeting for a variable income, but it’s still totally do-able! Here’s a preview of the annual budget spreadsheet below included in the homework assignment. As you can see (or somewhat see-it’s small but you can click on the picture to enlarge it), it is exactly the same as the monthly budget spreadsheet, except with totals all of the monthly budgets. This annual budget spreadsheet links directly from the monthly budget sheets.
STEPS TO CREATE YOUR FIRST BUDGET
So where do you start to create your budget? I’ve broken out the steps for you below. If you’re using this spreadsheet, be sure to follow the instructions on the first tab to edit, add or delete categories so that everything still links appropriately. I definitely suggest though that instead of adding and deleting rows, you edit existing descriptions as described in the instructions. This will be especially useful in future classes where I’ll be giving you extra resources that match this budget spreadsheet (such as recommended budget percentages, emergency fund tracking, tax estimating).
Step 1: Adjust Your Budget Categories
First, adjust your income categories. Look at your pay stubs and sort out those categories first. Edit any additional payroll income items and any additional payroll deductions specific to your situation. After looking at your pay stubs, edit the “Other Income” categories to include any other income that you receive (such as interest, alimony, settlement payments, etc.)
Second, adjust your expense categories. Make a list of all your monthly, quarterly and even annual bills, such as rent/mortgages, utilities, insurance payments, etc. and a list of all your daily expense categories, such as groceries, eating out, etc. Use the spreadsheet as a guide to make sure you don’t miss anything, but add or edit anything else specific to your situation.
Consider breaking down categories that are your “problem” areas. For example, if you’re spending more on eating out than you would like or can afford, break down the eating out category between coffee & snacks, eating out-work lunches and eating out-dinner. Then set separate budget amounts for each category. If you’re new to budgeting, I do recommend to keep categories to a minimum so that you’re not so frustrated spending so much time allocating all your expenses that you give up.
Step 2: Add Budget Amounts
Include your best estimate for the amount that you spend each month for your monthly expenses. These include things such as cable, cell phones, utilities, mortgage payments, etc.
Then move on to budgeting the monthly totals of your daily expenses such as groceries, eating out, entertainment, etc. based on the amounts from tracking your expenses for a month. At first, don’t try to too drastically cut your expenses for your budget, since if you deprive yourself at first in all your budget categories, you are likely to overcompensate by spending excessively later and not be able to stick to your budget. Just commit to making progress and you’ll get there! It is essential that your budget be realistic or it will not be a useful tool for you.
If you’ve committed to creating a zero-based budget, you will need to adjust your budget after entering all your expenses so that you’re budgeting every dollar of income earned, but not budgeting more than you earn.
There are numerous budget guidelines out there that suggest to you what percentage of your income should be spent on main categories of expenses such as housing, transportation, food, clothing and entertainment. It’s worth checking how you compare when you’re first setting up your budget, so we’ll be covering more about this tomorrow.
If you discover that your estimates are off later, just adjust them at that point in time mid-month or for the next month. No big deal! If you’re just starting, it will take a few months to get everything sorted out.
Step 3: Track Your Expenses
During the month, you’ll continue tracking your expenses either in your notebook, spreadsheet or your personal finance software. As I mentioned before, I use YNAB to track my budget and expenses in a very similar format to this spreadsheet. It has the added bonuses of being able to import transactions directly from bank and credit card accounts, making it much easier and way less time-consuming than manually writing down or entering expenses, and automatically categorizes your transactions based on previous ones from the same store. The best part of using a personal finance software such as YNAB is that it makes it incredibly easy to keep your budget current so that you can always look at how much you have left to spend for the month and make decisions based on that. And also, most of the popular software programs have a mobile app you can use on the go.
Step 4: Compare Budget to Actual
Transfer your monthly income and expense totals you’ve been tracking into the spreadsheet and it will calculate the difference between the amount you budgeted and the amount you actually spent that month. Make notes for significant differences-for example, if you went over by $200 in the grocery column because you forgot to budget for a birthday party that month.
Step 5: Revise Your Budget
There’s no sense in creating and trying to stick to an unrealistic budget. If you find that you are consistently over-budget on specific categories and you don’t feel like it’s something you want or really honestly need to cut back on, just adjust your budget. If things are tight, you may have to sacrifice in another area. For example, if you’re dual-income family with kids in many activities so you often eat out on weeknights, it may not be realistic to cut the eating out budget. But, you should have a lower grocery budget to compensate, or you should cut down on something else that’s not as important to you if you don’t have enough money for savings goals.
ANNUAL CASH FLOW STATEMENT
The cash flow statement could be considered somewhat of a test of how well you did sticking to your budget, but it’s also a picture of everything you spent money on during the month or year. Since we often think of our income in terms of our annual salary, the annual cash flow statement will show you the complete picture of where your annual salary was spent on during the year, including taxes and deductions (do not forget to include these!).
The Annual Cash Flow statement looks exactly the same as the Annual Budget, it just pulls from the actual column instead of the budgeted column on the monthly budgets sheets.
This may sound like a lot of work, but it’s the cumulative effort of a little bit of planning where you want your money to go each month and then regularly tracking where your money has actually gone. Just take it step by step and make sure to set aside a consistent time each week that you work on your finances.
EXAMPLE: THE SMITH FAMILY
The Smith family is tired of being in debt, which is why they were motivated to track all of their expenses. After having done that, they’re now ready to create their budget and move forward with their financial goals. They started by creating a budget for February 2016, the month after they started tracking their expenses. Here it is below:
Note that they had to create a category under savings goals entitled “Use of Previous Savings” because Jim’s income is so variable that they sometimes use previous month’s earnings to cover this year’s expenses. For February, this amount was only 88 cents.
Then they went back and created a budget for the entire 2016 year because they knew it was important to have an idea of the year as a whole with the bulk of their income being so variable with Jim’s job as a real estate agent. In order to estimate Jim’s income, they looked up all of his pay statements from the prior year (2015) and used them as a basis for this year, since the real estate market is similar, if not better this year (since I’m selling a house this year, this is my hope at least!). Click on the annual budget to get a PDF for a larger view.
In creating their annual budget, they wanted to have a zero-based budget, but there are months where their expenses exceed their income, due to Jim’s widely fluctuating commissions on real estate sales. To make up for this, they created a category under Savings Goals titled “Use of previous savings”. Any month that they can earn more than they spend they’ve put in “Savings-Emergency Fund”, but most of this money will be used for future month’s expenses when Jim’s income is lower than usual. This is why it is so important to budget, especially if you have commission or variable pay or own your own business! If you’re living paycheck to paycheck on a variable income, you will spend everything on your good months and not be saving for your lower income months.
Some of the other things that they were surprised by when they looked at the annual totals of how much they were spending included:
- They are annually spending $1,080 on cable and $1,260 on cell phone bills respectively. That is a lot of money! They plan to look into reducing these costs.
- Between auto payments, insurance and gas (they didn’t even budget repairs and maintenance yet), the total is over $8,000 for transportation costs. They can’t do with only one car since they both work, but they are shocked by this number.
- Paying off their credit card balances is a HUGE priority for them, but there isn’t a whole lot of room in their budget for extra payments.
- They would like to look into decreasing some of their other every day expenses such as groceries, clothing, etc. to see if they can put more of that money toward saving & debt payments.
Your homework assignment is to set up your budget categories and start using your budget.
- IMPROVING– Quickly estimate your budgeted monthly income and expenses to make sure that your income is greater than your expenses.
- INVESTED– Set up your current or next month’s budget and track your expenses according to the categories listed.
- UNSTOPPABLE– Set up your annual and monthly budgets with updated, detailed categories and track your expenses based on those categories. Update your budget each month for predicted holiday and seasonal expenses.
File your monthly budgets in your Annual Budgeting Binder under the month in which you created the budget. File your annual budget in the very front of your Annual Budgeting Binder.
Here is a list of seasonal and holiday budget expenses that you should consider when setting up your annual and monthly budgets. These are additional expenses that I often miss when setting up my budget for the month. Also, there’s a list of a few other expenses you may be forgetting at the bottom of the list such as birthdays, annual dues and more.