Financial Management,
July 25, 2020

7 Steps to Budgeting

Gregory Weiss
7 Steps to Budgeting

Today I'm going to tell you in 7 steps how to put together a budget! In the previous post we already talked about the importance of having a personal and updated budget, so in this one it's time for us to get to work! I recommend that you find a place where you feel comfortable, prepare a nice cup of tea or coffee and sit patiently with your computer or your notebook!

1. Identify your monthly income and expenses

The first step is to take note of all our income and monthly expenses as of today.

The income part is usually easier because most of us get a monthly salary if we work in a relationship of dependency. However, for those who are independent and receive income from different clients, it is important that they can estimate the income for at least the next 3 months or that they analyze how much money they received in the last 6 months and in function of it they can obtain an average income.

Then to identify all the expenses we have to:

  1. Look for statements of our bank accounts.
  2. Find the statements of all our credit cards.
  3. Look for invoices that reach our home or mail.

And finally identify the amount we spend on miscellaneous expenses that we don't have identified. They would be small expenses but in their totality they can be important. For example, if I have income of 10,000, I have expenses with my cards of 3,000, expenses identified with my debit card of 3,000 and monthly savings of 2,000. By difference I know that I spend another 2,000 in miscellaneous expenses in cash that I do not have identified for now, since the sum of all these items adds up to the 10,000 that represent my monthly income.

With all this information we should begin to build an excel to build our monthly budget (this is fundamental, you can not keep the accounts in a notebook if we really want to commit to this long-term goal).

2. Classify your expenses and identify your current financial situation

Once we have the list of our expenses listed, we have to classify them into different categories. Here are 2 groups of categories that you could use and what expenses can be included in them.

Fixed Expenses

  1. Housing: rent, hipetecary credit, expenses
  2. Food: supermarkets, Chinese, greengrocers, dietetic, etc.
  3. Travel expenses: gasoline, loading, uber, taxi, cabify.
  4. Health: medicines, medical care, psychologist, social security contributions,
  5. Services: Gas, Electricity, Cellular, Water, Cable, Internet
  6. Cleaning: Household cleaning, dry cleaning

Variable Expenses

  1. Clothing: clothing, footwear, wallets, belts, everything related to our clothing
  2. Beauty: depilation, make-up, hairdressing, nails, gym, pilates, beauty centre, etc.
  3. Entertainment: cinema, theatre, outings with friends/partner/flia, etc.
  4. Other meals: office/work lunches, delivery, food.
  5. Extras: Starbucks cafecito, kiosk, non-recurring expenses.

I identified them in a category other than food, because I wanted to know how much money I spent on that concept, since it is a point where it is easy to reduce expenses if we take food from our homes.

Once we have all the estimated income and expenses in an excel we can know what our current financial situation is. For example, do we have money left over every month? can we save more by reducing certain unnecessary expenses? or on the contrary, are we spending more than we earn? and are we financing ourselves with credit cards? How much money do we have saved?

Is it enough to pay at least 3 or 6 months of our monthly expenses? These and many other questions we can ask ourselves to identify our starting point for our finances and then move on to the next step!

3. Define Financial Objectives

This step is about being clear about what we want to achieve with our income. This means where we want to go ? or what we want to achieve with our income ? a trip ? the purchase of a property ? the development of an enterprise ? saving for the education of our children ? creating a reserve fund that allows me to live without working for a certain period of time ? The options are thousands!

The interesting thing about this point is how our financial objectives relate directly to our dreams. This is where we understand that money is a means to achieve our dreams and thanks to the definition of these objectives we will be able to have the necessary strength to keep our finances in order.

Here are some examples of these goals:

  • To create a Reserve Fund which allows me to cover between 3 and 6 months my fixed costs.
  • To have my credit cards without debt, that is to say that every month I pay the totality of the account summary.
  • Reduce my variable expenses in order to save more money.
  • Save for a car, an apartment or a trip. Analyze how much money to save each month and for how long to achieve that goal.
  • Start investing my savings.
  • Generate additional income or achieve financial independence.
  • Generate my own entrepreneurship.

And why is this important? Because the fact of having clear objectives motivates us and encourages us to have our budget ordered and updated. Because by reviewing our budget monthly we will be able to see how we have advanced or not in reaching our objectives.

4. Create an action plan

Once we have identified our current financial situation and new targets, we need to start thinking about how we are going to achieve those targets. For that I'm going to show you with an example some definitions that worked very well for me:

For example, let's suppose that my objective is to buy a car. The analysis should go from target to today, which would be something like that:

1) How much money do I need to buy the car?

Example 300.000 pesos. --> My financial objective = My desired future situation.

2) How much money do I have saved today?

Example 50.000 dollars --> My current situation.

3) How much money do I need to save?

Example: 250.000 dollars -->My Financial Goal.

4) How much money am I saving each month?

Example: I save 8,000 dollars per month -->My means to reach the goal. My action plan.

5) How much time do I need to reach the goal?

Example: if I save 8,000 dollars per month, then I need 250,000/8,000 = 31 months.

I need 2.6 years to reach my goal -->My definition of the term (time).

6) Identify your possible shortcuts (accelerators) or detours (imponderable expenses)

Example of shortcuts: If I manage to reduce my variable expenses, I could save that additional money which would shorten the time to reach my goal or if I obtain clients as independent I would have more income and consequently more savings-->Accelerators or Containment Plans.

Example of detours: If I have a contingency and I have to spend more money than usual, that month my savings would be lower and therefore the term would be longer --> Detours or Imponderable Expenses.

Having identified these two points, allows you to have a plan B in the event that some imponderable is presented so as not to delay the achievement of your goal.

As a summary of this point, to put together your action plan you have to:

  • Identify your objective, your goal, your means, your deadline and your control method.
  • Identify the steps necessary to reach your goal.
  • Define control instances or revision key dates
  • Identify any shortcuts or detours you might have.
  • Review and re-plan if necessary, but never stop controlling how you are doing with the fulfillment of your goal and your objective will finally arrive :)

5. Identify tools to comply with the action plan

Once you have defined the actions you must take to achieve your objectives, it is important that you identify the tools that can help you carry out your plan. Here are some that might be helpful:

  • Use an App to record all expenses.
  • Take an excel to write down expenses on a weekly or monthly basis.
  • Reward yourself before each goal reached, to continue motivating yourself.
  • Define a day a week to control your expenses.
  • Ask your partner, a friend or family member to help you with the follow-up.

6. Monitor and analyze monthly

Tracking your spending means, on the one hand, writing down everything you spend and, on the other hand, analyzing what you are spending on.

To control it is essential to have an amount of money allocated to each category of your budget. For example for food depending on what I spent in previous months I know that I spend approx. $ 7,000, so that will be the maximum amount I am allowed to spend on that category and if I'm looking to reduce expenses I can set as a goal to lower 10% that expenditure. This way my new budget for food will be $6,300.

At the end of the month, we must review:

  • If we spend for each category what we really estimate.
  • If we meet the assigned quota for monthly savings.
  • Identify expenses that were lower than the estimates and understand why that happened.
  • Identify expenses that were higher than the estimates and understand why this happened.
  • Understand what we spent our money on this month.
  • Plan how we are going to use our money next month.

7. Create new healthy financial habits

This point is last but not least important, because ordering our finances implies not only dedicating time to analyze our expenses from time to time, but to do it well we must create a system of new habits that allow us to maintain order in our economy over time in order to achieve our objectives.

Otherwise it is as if we decided to go on a diet for a month to lose weight instead of changing our eating habits to stay healthy in the long term.

Although I believe that there are certain habits that apply to everyone, it is ideal for each one to identify the habits that are easiest for them to keep their budgets updated over time. Below I share with you which were the ones that I incorporated and allowed me to organize my economy:

  • Record all expenses at the end of the day. To make it easier you can use an App and then put that information in your budget (Excel).
  • Spend one hour a week reviewing the week's expenses for each category and completing the Excel of your monthly budget.
  • Choose a sponsor for your finances. This would be asking a friend or family member to consult you on a regular basis on how your economy is coming, so that if you didn't sit down to review your finances, at least you would feel uncomfortable responding and when you get home do it!
  • Before making a purchase, review your budget to ensure that you can make that expense without disrupting your economy.
  • Write down the things you need in a note on your cell phone. So before you buy something you can check that note to make sure that what you're going to buy is really necessary.
  • Make a list of things to buy in the supermarket before you go, to avoid buying unnecessary things.

That's it for today! They already have the steps, they have the excel and they have the habits that worked for me, it only remains to begin!

Continue reading