The No Debt Plan: Step One: A Budget

by Kevin on February 27, 2008

This is the fourth post in a series: The No Debt Plan.

I have been afraid of writing this post for some time. Out of anything I will ever write on this blog, this is by far near the top of the list of the most important topics. To succeed in your financial life, to run your No Debt Plan, to really understand what is going on… you must be able to budget. There is no alternative. Call it a spending or savings plan if you like, when it comes down to it they are all the same — a budget.

Definition

From Webster’s Dictionary:

4 a: a statement of the financial position of an administration for a definite period of time based on estimates of expenditures during the period and proposals for financing them; b: a plan for the coordination of resources and expenditures; c: the amount of money that is available for, required for, or assigned to a particular purpose

Whew! Quite the mouthful.

I define slightly differently. A budget is a tool that

  • lets you see where your money is coming from, and
  • lets you tell it where to go

I think that last little bit is especially important. A budget doesn’t tell you where your money went. Your money shouldn’t be going anywhere without you knowing about it. It does show you were you told it to go.

The Pieces of a Budget

Your budget will have three main pieces – income, expenses, and free cash flow. Hopefully income is greater than expenses. This leads to free cash flow. I’ll talk more on understanding free cash flow in the future, but essentially it is what is left after expenses are deducted from income. If everything is going well, it is a positive number. If you are spending more than you are earning, it is a negative number.

Income is simply any money you bring in during the month. We typically only count income from jobs in this category. We use gifts, rebates, or money made selling personal possessions differently. Expenses are the things you spend your money on. Rent, utilities, food, gasoline, debt minimum payments, and car payments are all examples of an expense.

Where to Start

The budgeting process can be very eye opening. If you are sitting at your computer reading this and you have no idea where your money goes each month, a budget will solve that very quickly. Again, the goal is not where to see where your money is going, but for you to tell it where to go. But! If you don’t even know where it is going, a budget will do that too.

So, where do you start? Let’s just start at the top of the list above: income. Where is your money coming in from, when does it go in your account, and how much is it. For most people this should be pretty simple with just one job. Total the amount of money you expect to bring in every month, especially this month. Precise numbers are better than generalities, but anything will do at this point.

Next up are your expenses. This can be where the headache starts, so try not to get discouraged. A lot of data is involved because you aren’t normally spending all of your money in one location (unlike income, which is usually just one or two sources). To get this data, look at your bank accounts and credit card activity statements. This should cover most everything. The bank accounts will cover cash withdrawals as well as debit card use. Credit cards will show you each location you are spending money. Figure out what category each purchase is in. Sometimes you just have to pick one category if it is mixed.

Now compare the two categories. If your income is $3,000 after taxes, and your expenses are $3,400… you are in the hole. If expenses are $2,900 you have some breathing room. Either way, you now know where you stand. Now what?

Tell Your Money Where To Go

Line up all of your expenses and determine how much you should be spending on them. Make a list of expense categories. Put what you normally spend next to the category name. Now, determine where you can cut back. This is where you are telling your money where to go. Commit to spend only $300 on groceries this month and don’t allow yourself to eat out. Call your cable company to reduce your cable package. Cancel that gym membership.

Once you make your adjustments, look at the bottom line. How much extra money could you save if you implemented your changes? This is money that can be applied to debt (and later in the process, for savings). Remember, you don’t necessarily need to earn extra income if you can commit to just cutting back.

This is a huge step and it does require some work. You aren’t going to find yourself debt-free in the future without doing some work. Later on in the process I’ll share some tools you can use to help set up a budget.

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Carnival Of Debt Reduction #129
March 3, 2008 at 4:03 am

{ 5 comments… read them below or add one }

Ricky February 27, 2008 at 1:23 pm

Budgets? We don’t need no stinkin’ budgets.
Only kidding, I couldn’t resist though. Infact I could not agree with you more on this Kevin. A budget was our first move in turning our finances around and getting rid of debt. By giving every dollar a name we found money we never knew we had. Consequently we were able to start paying more on debt before we ever even cut anything out of the budget. If you are not budgeting start today, you’ll be amazed with what you discover.

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Master Your Card February 27, 2008 at 11:34 pm

Great post! Really looking forward to the next in the series!

Jonathan

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Ed Ness March 20, 2008 at 1:48 pm

I enjoyed this very much! I’ll be reading your posts regularly, as I’m finally endeavoring to get myself out of debt now. Thanks!

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Mr. Arkin June 18, 2008 at 1:45 pm

I totally agree. I started a budget about 1 year and a half ago. I got out of debt about 4 months ago. I also got a salary raise. Since i have a good and well organized budget i was able to utilize all that extra cash to “pay myself first”. For anyone who hasn’t started doing a budget it takes quite a few months to really get it right. I am still making slight improvements to mine every month and i have been doing it for a year and a half… without a doubt a budget has been the best money making tool i have learnd!

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Kerri October 5, 2009 at 5:21 pm

From the “where do I start?” and “where do I stand?” perspectives regarding income and expenses, a useful new site just launched that is an ideal starting-off point for budgetary novices. There are certainly more involved financial sites out there, but this one is quick and easy–a solid step one: http://www.debtspark.com

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