This article is the 2nd in the series Creating and maintaining a real budget:
In the article Know what you spend we discussed how and why the need for collecting 12 months of your past expenses. Without a complete set of those it is hard to get to a real and complete budget. Collecting your expenses however is only the first step on your way to creating that budget. Once you’ve collected the expenses, you are now to actually organize them.
You need to be able to make sense of your past behavior before you can make decision on how to direct it going forward. You cannot do this against one big lump sum (last year we spend $57,000, is good to know but fairly useless).
Break down all of your expenses in with the following in mind:
- What categories you spend your money on.
- How much you spend on each of these categories.
- When you incur the expenses for different categories.
Leave no expense without categorization. It is hard to make financial decisions if your budget is missing sums of money. It might be useful to look at the list I use for our budget. It encompasses every category we spend money on.
- Gifts given
- Home owner fees
- Home maintenance
- Gas & Electric
Discretionary actually breaks down into many categories but based on past expenses can assign an amount to it that will dictate all discretionary spending once a budget is created.
If you do have trouble placing something under a certain category, add it to something like a “miscellaneous” category. Revisit miscellaneous items later when you’ve finished categorizing all other expenses. Chances are you’ll now find a category to place it under. If it still cannot be placed it is most like an expense that won’t occur again and will have no consequence on future budgets.
Clearly there are categories that may not apply to everyone. You may not have a mortgage but pay rent instead, in which case, several other items like home insurance and even some utilities may drop off as well. You may not be paying tuition as you have no kids or your kids are in public school (not entirely free either). You probably vacation, which represents a major category and expense by itself. Other very likely categories would be car loan payments and the now almost ubiquitous student loan payments.
Another likely category could be credit card payments if you are currently in debt. Spoiler alert, every dime you can cut from your budget should then of course go to paying of that debt (but I digress).
At this point software tools come in handy to start organizing your expenses. Falling back on Quicken, it allows me to categorize all my expenses and labeled them accordingly. Every time a new expense is downloaded from one of your many accounts, Quicken will attempt to categorize it automatically based on past expenses. If it cannot, you can assign it a category from a list you’ve assigned to your budget manually.
This step in creating a comprehensive budget can be a tedious one as it may involve hundreds if not thousands of transactions. The good news is that if you use a tool like Quicken, after this step it will all be incremental and much more manageable.
At the end of this step you will have every transaction for every account assigned with a category and you know exactly how much is spent on each category and when it is spent. Why do you care about when it is spend? Well a proper budget should really be broken down by expenses per month. Some months are simply more expensive than other. By knowing when these spikes in expenses occur (be it Holiday, vacations or once yearly bills) you can plan accordingly.
At this point we’ve gone through steps 1 and 2 of creating and maintaining a real budget and still haven’t started budgeting yet. We do now have all the tools and information to start creating the budget. The next article Budgeting: Creating the budget will cover this in detail.
Good luck reaching your financial goals.