7.2 Understanding the Budgeting Process

Creating a budget involves organizing your financial life into two main categories: income and expenses. By gaining a clear understanding of both, you can ensure that you live within your means and work toward financial stability and long-term goals. Balancing these two categories allows you to take control of your financial future and make informed decisions about where and how to allocate your resources.

Income: What You Receive

Income refers to all the money you receive from various sources. It’s essential to capture all streams of income to fully understand your financial capacity. Your income might include:

  • Salary/Wages: Your primary source of income from employment, whether it’s full-time, part-time, or freelance work.
  • Government Assistance: Programs like unemployment benefits, food assistance, or child welfare payments.
  • Child Support or Alimony: Payments you may receive as part of a legal settlement or agreement.
  • Investments or Dividends: Earnings from investments, stocks, or interest from savings accounts.
  • Side Gigs or Freelance Work: Any additional money earned from part-time jobs, freelance projects, or selling items online.

Action Tip:
Don’t forget irregular or seasonal income. If you receive occasional bonuses, financial gifts, or tax refunds, consider how these fit into your overall income plan. While these aren’t consistent, it’s crucial to account for them when planning for large purchases or building an emergency fund.

Expenses: Where Your Money Goes

Expenses encompass everything you spend money on. These can be broken down into two main categories: essential expenses and non-essential (discretionary) expenses. It’s crucial to identify which of your expenses are necessary and which can be adjusted if needed.

  • Essential Expenses:
    These are the costs that are unavoidable and typically must be paid every month, including:
    • Rent or mortgage payments
    • Utilities (electricity, water, gas, etc.)
    • Groceries
    • Insurance premiums (health, car, home)
    • Loan or credit card payments
    • Transportation (car payments, gas, public transit)
  • Non-Essential Expenses:
    These are the more flexible, discretionary costs that, while they enhance your quality of life, aren’t strictly necessary for survival. Examples include:
    • Dining out
    • Entertainment (movies, concerts, subscriptions like Netflix)
    • Hobbies and leisure activities
    • Clothing (beyond essentials)

Action Tip:
Distinguishing between “needs” and “wants” is key. For example, food is essential, but dining out frequently may not be. This distinction helps you identify areas where you can cut back when necessary.

Action Step: List Your Income and Expenses

Step 1: List Your Income
Write down all the sources of income you have, both regular and irregular. Include everything from your paycheck to government support and side jobs. Be sure to differentiate between gross income (before taxes) and net income (the amount you actually take home after taxes and deductions).

Step 2: List Your Expenses
Go through your bank statements, credit card statements, and bills to list every expense. Categorize these expenses into “essential” and “non-essential” to get a clear picture of where your money is going. Make sure to account for both fixed expenses (which stay the same every month) and variable expenses (which can fluctuate).

Example:

  • Income:
    • Salary: $3,000 (net)
    • Child Support: $500
    • Side Gig Income: $200
  • Essential Expenses:
    • Rent: $1,200
    • Groceries: $300
    • Utilities: $150
    • Car Payment: $250
    • Health Insurance: $200
  • Non-Essential Expenses:
    • Dining Out: $100
    • Streaming Services: $40
    • Entertainment: $75

By completing this exercise, you’ll have a clear picture of your financial situation and can identify areas where you may need to adjust.

Next Step:
Once you have listed your income and expenses, compare the two. If your expenses exceed your income, it’s time to make adjustments by either cutting back on non-essential spending or finding ways to increase your income.