It’s nearing the end of the month, and your bank account is almost empty. It’s the same situation that happens every month. And the biggest mystery is that you just can’t figure out where all your salary just went. If you can resonate with this, it is time for you to work out a monthly household budget. This article explains how you can create a budget. It also gives some helpful tips on how to budget effectively and increase your family’s financial well-being.
Why should you create a monthly budget?
Think of yourself as a CFO of your family. Like a company’s CFO uses the cash flow statement to make money decisions for the company, a monthly budget can benefit in the following ways:
- Helps you get an accurate picture of your financial situation and savings potential
- Saves you from sleepless nights worrying about your finances – once you are clear, you can take action
- Makes you aware of unhealthy money habits
- Helps you make a plan for reducing expenses and finding out new sources of income
- Helps you determine the size of the emergency fund
- Protects you from costly credit card debt and personal loans
- Helps you start investing for your financial goals instead of letting the money lie idle in a savings account
5-step guide to creating a monthly budget
A monthly budget does not require you to be a mathematical wiz or something. It only requires a pen, paper, calculator and some time and effort.
Step 1: Calculate your monthly net income
In this section, you need to calculate your monthly income from all sources like salary, rent, interest, dividends, business income grants, alimony, etc. Note that the income should be considered post-tax. If the income is before tax, you can estimate tax liability and then include the net tax amount. For income that you don’t earn every month, you can estimate the annual income, divide it by 12 and include it in this calculation.
Step 2: Calculate your monthly expenses
Calculating income is relatively straightforward. The major challenge comes in calculating expenses. For doing this, you should use a diary and note down all expenses done by the end of the day. Alternatively, you can also use an expense tracker app. For expenses that don’t occur monthly, you can calculate the monthly share and include it in this calculation. Make sure to also include any EMIs that you are presently paying. Also, take care to refer to your bank statements and credit card statements to include online payments in your calculation. Do not consider any investments in this section.
Step 3: Calculate monthly savings
Now you have the monthly income and monthly expenses. Reduce the expenses from income and find out the net monthly savings.
Step 4: Create a budget and goals
This is the most crucial step. In this step, you need to critically analyse the monthly cash flow. You can rely on the 50/30/20 rule, which says that you should spend 50% of the income on necessities, 30% on wants and 20% on investments.
Suppose your monthly savings amount is negative or in a low-positive range. In that case, you need to take steps to increase your income sources and, at the same time, decrease any discretionary expenses.
After doing the analysis, you can arrive at a monthly budget that clearly lists the expected income, expenses and savings. Now that you are clear on the savings, you can plan your investments (for example, activate SIP in good mutual funds).
Step 5: Track your progress
Creating a budget is not a one-time activity. You need to keep tracking your income and expenses every month. You can dedicate a time slot for this at the end of every month. During that time, you can compare the budget against the actuals and analyse the variation.
Some tips on creating an effective budget
Below is a list of some helpful budgeting tips that can increase the effectiveness of budgeting exercise:
- Try to automate your monthly investment. For example, you can do a SIP in 2-3 mutual fund schemes or invest a fixed amount at the start of the month. This will help you clarify how much money is left for spending for the rest of the month.
- If you get an impulsive thought to purchase a gadget, estimate how it will impact your budget.
- Nothing works like a reward – at the end of each month, treat yourself to something as small as a bar of dark chocolate or a cosy meal with your wife.
- If you have irregular income, you can observe the income and expense pattern for a few months to find an estimated monthly amount.
- As the legendary investor Warren Buffet said, do not depend on a single income. Try to build additional sources of income.
- Keep a buffer of 10-15% in your expense calculations to take care of emergency expenses
- Use the expense calculation to build an emergency fund equivalent to a minimum of 6 months of expenses.
- Allow the budgeting exercise to raise your awareness of destructive habits like smoking, gambling, excessive shopping etc., and make action plans to remove them.
Research studies have shown that households with some rules around money save much more than those that don’t. Having a budget gives a clear direction on how to spend your hard-earned money. Apart from making a consistent and disciplined budgeting effort, you need to also improve your money and lifestyle habits to lead a healthy financial life in the long term.
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