Believe it or not, there is a difference between creating a budget, and creating a functional budget. Creating a budget is easy. You sit down, decided how much money you think you should spend and try to follow it. Unfortunately, those types of budgets have a tendency to be unrealistic. That is why it’s vital to create what I call, a functional budget.
Figure Out How Much You’re Spending
Keep track of your expenses!
In my former life, I worked as a bankruptcy counsellor, and part of my job was helping clients create functional budgets after declaring bankruptcy. During counselling sessions, I’d ask clients to keep track of their spending for a month. Why? Because in order to create a budget that is easy to follow, and makes sense for your income, you need to figure out exactly how much money you’re spending.
You need to keep track of every single penny you spend for a one month period. It’s tedious, but you’ll be amazed to see how you’re spending your money. This exercise is not a particularly fun one, but it is a necessary one. You can choose between one of the following methods:
- Buy a small notebook; small enough to carry with you. Each morning write the date at the top of a blank page, then as you spend your money, write down how much you spent (to the penny!), and where you spent the money.
- If remembering to write things down as you spend is a scary thought (I seem to forget to write things down, especially if I’m in a rush), then make sure you keep receipts for absolutely everything you bought during the day. Then record what you spent at the end of the day.
Figuring out how much (and where) you’re spending each day is two-fold. We’ve talked about carrying a notebook and recording everything you spend, and now we’re going to talk about creating a ‘Monthly Expense Tracker’.
At the beginning of the month sit down and create a money tracker. You can do it in a program like Excel, or you can draw one out. Whichever is easiest for you. Your monthly expense tracker should have categories that fit with your lifestyle, things you spend money on every month. Include categories like food, cigarettes, alcohol, transportation, gas. Anything that you buy throughout the month.
Monthly Expense Tracker
|Dec 13, 2012||$15.18||$3.00||$18.18|
|Dec 14, 2012||$4.59||$21.37||$25.96|
The number of columns depends on what type of things your spending money on.
Each night when you’re going through your expenses, lump them into categories, add up the total for each category and write in into the appropriate column in your money tracker. If you don’t have a column for something, make one! It’s important to be completely accurate. The point of this exercise is to learn where your money is going, and how much of it. At the end of the month, you may be surprised to see exactly how much you spend on cigarettes, booze, food…
Income vs Expenses
Figuring out how much you’re spending is a bit of a wake-up call and an integral part of creating a functional budget. The next step in the process is to compare your income and expenses. All of it!
In this exercise I want you to grab a piece of paper (or open a new worksheet in excel), your monthly expense tracker, and your pay stubs.
The first step is to find out your monthly income. If you’re paid a salary (or hourly with set hours) this part will be easy. If you’re paid hourly and do not have set hours, then add up your net income from each paystub over the past 6 months, and divide the total by 6 to get your average monthly income. This is the income we’ll use for this exercise.
When you’re listing your income (payroll, child support, spousal support, social assistance, employment insurance), include tax credits (this is common in Canada). Things like money you earn by selling your things, odd jobs etc. are hard to pinpoint, so leave those off for now.
This is probably the most important step, writing down your discretionary and non-discretionary expenses. This is what I want you to do. Start with your monthly non-discretionary expenses (these are essential expenses). Write down the ones that apply to you, and the monthly cost. Many of you won’t have these expenses.
As I mentioned above, many of you won’t have non-discretionary expenses, however, all of you will have discretionary expenses. For this part of the exercise, I want you to divide your discretionary expenses into columns: monthly, quarterly, and annually.
When you list your expenses, look at your monthly expense tracker. Make sure all of those expenses are included in this exercise. Also think about things you buy every couple months or every year. List everything you can think of, this needs to be a realistic view of what your expenses are in order for you to create a functional budget.
Add up your quarterly expenses and divide the total by four. This will give you the monthly cost of those expenses. The add up your annual expenses and divide the total by twelve. Add all of your non-discretionary and discretionary expenses together (including the monthly total for your quarterly and annual expenses) to get your total monthly expenses.
Take your monthly expense total and subtract that from your monthly income total. Do you break even? Are you overspending? Do you have surplus income? Welcome to wake-up call number two!
Creating a Functional Budget
Now that you know where you stand in terms of your spending habits, and your income vs your expenses, it’s time to create a functional budget. If you’re overspending each month now is the time to decide where you’re going to make cuts in your spending, but I’ll touch more on that in a bit. The first thing I want you to do is to create a budget spreadsheet in excel or buy an accounting book.
Create columns for each expense, and remember to include a column for your travel fund. After all, we’re creating a budget so it’s easier for you to see what your spending, and how much money you’ve saved for your travels!
Let’s start with your expenses first (we’ll add your savings column in a bit). I find it easier to put things into sections. The first part of my budget has my set expenses like rent, telephone (I have a set plan), car insurance, car payment.
|Date||Rent/Mortgage||Telephone||Cable||Internet||Car payment||Car Insurance|
Once I have my set expenses, I add on my other monthly expenses. Like this:
|Date||Rent/Mortgage||Telephone||Cable||Internet||Car payment||Car Insurance||Food||Utilities||Clothing|
Remember: Life is unpredictable. Things happen. Cushion your budget. Take what you’re spending, and add some extra money to each column as a ‘just in case’ measure.
Now that you’ve allotted money for necessary expenses, it’s time to figure out how much to budget for the fun expenses, as well as for your travel fund! The first thing I do is add up the budget totals I have written down, then subtract that number from my monthly income. I then use this new number to decide how much I want to budget for each of my fun expenses.
Let’s say I have a surplus of $380 for my fun expenses. I’m currently saving to move to Asia, so I may decide to budget $200 a month for my expat funds, then divide the leftover money between my other fun expenses.
|Date||Expat Funds||Movies||Going Out||Misc. Spending|
Using Your Budget
Once you’ve created your budget, it’s time to start using it. The best way to do this is to record your expenses each night before bed. Not once a week. Not once a month. If you want to control your spending and have a realistic view as to where your finances are, you should enter your expenses each night. By doing it nightly you can see exactly where you are; which allows you to make adjustments.
Adjustments? Yep! When you start using a budget you’ll discover that you’ve either budgeted too much or too little for certain categories. Is it Wednesday and you’ve already spent 80% of your food budget for the month? Yikes! It’s time to evaluate what your spending, and possibly adjust your budget so you have a little more money in your food budget, and less in another area. The key is to not sell yourself short. Don’t create a really tight budget in the beginning. Give yourself breathing room, then tighten things up a few months down the road; when you’re comfortable with your budget and know your spending habits and needs.
|Date||Rent/Mortgage||Telephone||Cable||Internet||Car payment||Car Insurance|
|15.11.12||+ $850||+ $120||+ $55||+$32||+ $200||$25|
|01.12.12||– $850||– $75.00||– $51.25||– $30|
|07.12.12||+ $425||+ $35||+ $125||+ $20|
- How to Budget & Save for World Travel: Practical Advice to Anticipate the Budget for Your Dream Trip and Save for Long-Term Travel by Shannon O’Donnell – An extensive guide on how to save money, even if you are living from paycheque to paycheque. Helpful advice on everything from spending habits to credit cards to budgeting money.
- Getting Rid of It: The Step-by-step Guide for Eliminating the Clutter in Your Life by Warren & Betsy Talbot – Learn about the best ways to get rid of all the stuff you don’t need as you travel the world, and how to do it in a way that adds money to your travel budget!
- How to Travel the World on $50 a Day: Travel Cheaper, Longer, Smarter by Matt Kepnes – The man behind the popular blog, Nomadic Matt, this book is a good resource for those figuring out their base travel budget.