Budgeting What Is a Budget? By Cassidy Horton Updated on April 26, 2022 Reviewed by Pamela Rodriguez In This Article View All In This Article Definition and Examples of a Budget How Does a Budget Work? Types of Budgets Do I Need a Budget? How To Create a Budget Photo: mixetto / Getty Images Definition A budget is a written plan that outlines how you’ll spend your money each month. Key Takeaways A budget is a written plan that outlines how you’ll spend your money each month.Both individuals and businesses use budgets to manage their cash flow and reach their goals.A budget is important because it shows you how much money you make each month and how you’re spending that money. Some popular types of budgets include the 50/30/20 budget, the 80/20 budget, the envelope budget, and the zero-based budget. Definition and Examples of a Budget A budget is a financial planning tool in which you write down how much money you expect to earn (i.e. your income) and how you plan on using it (i.e. your expenses). Individuals and businesses alike use budgets to track their cash flow and reach their goals. Alternate name: Spending plan One popular budgeting method is the 50/30/20 budget. You use 50% of your income for needs (such as rent and utilities), 30% for wants (such as shopping and eating out), and 20% for savings (such as an emergency fund, paying down debt, or building up your retirement fund). How Does a Budget Work? The purpose of a budget is to help you track your spending so you can use your money to reach your goals. “Budgeting helps you decide upfront how to spend your money,” said R.J. Weiss, CFP and founder of The Ways to Wealth. “Everyone has different priorities and goals. By budgeting, you're making sure your priorities and goals are being put ahead of expenses that aren’t as important.” After you set up your budget, one of three things will happen: You’ll have a balanced budget: This means your income equals your expenses and you aren’t spending more money than you make. You’ll have a deficit: This means you’re spending more than you make and possibly going into debt. You’ll have a surplus: This means you’re spending less than you earn. You can use the extra money to save, pay off debt, and reach your goals. Here’s a closer look at how a budget works for individuals and businesses: Personal Budgets The whole point of a personal budget is to help you spend less than you earn so you can use the difference to reach your savings goals. In its simplest form, a personal budget works like this: At the beginning of each month, you create a written plan for how you’ll spend your income. Next, record your expenses at the end of every day to track your progress. (A spreadsheet or budgeting app can be helpful here.) Your expenses will likely fall into one of three categories: Fixed expenses: These expenses cost the same amount of money every month and are typically non-negotiable. Some examples are rent or a mortgage, car insurance, your phone bill, and some utilities. Variable expenses: These expenses are necessary, but the cost varies month to month. Examples include groceries, electricity, transportation costs, and vehicle maintenance. Discretionary expenses: These expenses are 100% fun and optional. They include anything from clothing and new gadgets to vacations and entertainment purchases. Finally, at the end of each month, you review your progress and use this month’s spending to plan next month’s budget. Personal Budget Example Starting monthly income $4,000 Rent $1,700 Phone bill $70 Health and Car Insurance $100 Car loan $350 Gas $135 Groceries $400 Takeout food $200 Clothing and beauty supplies $220 Entertainment $100 Subscription services $150 Miscellaneous expenses $75 Debt payments and bank fees $700 Ending monthly budget -$200 Your income is higher than your expenses, so you have a deficit budget. You already had a gut feeling this was true because you couldn’t pay your bills on time. But now, thanks to your budget, you know exactly where your money is going each month. You need to free up at least $200 in your budget, so you start trimming expenses on takeout food, clothing, entertainment, and subscriptions—all things you want to spend money on but you can’t necessarily afford right now. You cut $50 from your takeout food budget, another $50 from subscriptions, $40 from entertainment, and you cut your clothing budget in half to free up another $110. Before you know it, you have an extra $250 in your budget. You put $200 of it toward bills and use the other $50 to start an emergency fund so you have a safety net to protect you from unexpected expenses. Types of Budgets There are almost as many types of budgets as there are flavors of ice cream. Consider trying out a few different types of budgets until you find which “flavor” you like best. Envelope Budget With the envelope budgeting method, you set spending limits for each of your budgeting categories and put that amount of cash in a physical envelope to help track your spending. Once you empty one envelope, that category is off-limits until you get paid again. 50/30/20 Budget With the 50/30/20 budget rule, you spend 50% of your income on needs, 30% on wants, and 20% on savings and debt repayments. So, if your take-home pay is $5,000 a month, you’d spend: $2,500 on housing, transportation, and other necessities (50%)$1,500 on fun things like dining out, shopping, and subscriptions (30%)$1,000 to pay off debt and reach your savings goals (20%) 80/20 Budget If you don’t like the idea of having to figure out what’s a “need” and what’s a “want,” consider the 80/20 method. With this budgeting rule, you save 20% of your income and use the other 80% however you’d like. Keep in mind, the 20% savings rate is just a guideline. You can change it to be a 70/30 budget, a 60/40 budget—whatever works best for you. This method is also called the “pay-yourself-first” budget or the “reverse budget.” Zero-Based Budget A zero-based budget is a strategy where you give every dollar a job so your income minus expenses equals zero. It’s not to say you spend every penny you own. Rather, you go ahead and divide your paycheck out among all your expenses, debt payoff, and financial goals so there’s none left over. Do I Need a Budget? Yes. A budget is important because it helps you pay your bills on time and save for the future. It also helps you find ways to spend less money on things you don’t value so you have more money to put toward your goals—such as saving for retirement, a vacation, a house, or a new car. Everyone can benefit from a budget, no matter how small or large your income is. Without one, it’s hard to know where your money is going each month. Note If the idea of manually creating a budget each month sounds tiring, give a budgeting app a try. These apps take the load off by syncing to your financial accounts and automatically importing and categorizing transactions for you. How To Create a Budget Whether for personal or business use, here’s how you’d go about creating a budget: 1. Add Up Your Monthly Income First things first, you need to figure out how much money you make each month. Use your net take-home pay for this step, which is the amount of money you bring home after taxes and deductions. If you earn a salary, you can find your net take-home pay by looking at your paystubs. If you have irregular income, add up all the money you made last year and divide it by 12. This will give you an estimate to work with. Don’t forget to include any other sources of income, such as Social Security, child support, side hustles, and more. Note Looking for a free budgeting template? The Consumer Financial Protection Bureau offers a simple but effective template. 2. Estimate Your Monthly Expenses Now it’s time to calculate your spending. Dig through your old bank and credit card statements to see how much money you spend each month. Some common expenses to add to your budget include: Rent or mortgage paymentsUtilities (gas, water, electricity, sewage)Internet and cableCell phone billGroceries and take outHealth expensesTransportation costsEducation and childcare costsPet costsDebt payments “If you're brand new to budgeting, consider budgeting just one spending category over the next month,” Weiss said. “For best results, pick a category you tend to overspend, such as eating out, grocery shopping, or entertainment. The idea is to start small, to give yourself the highest possible chance of success. From there, you'll gain confidence and skill in your ability to budget, and be able to apply it to other areas.” Note Don’t forget about budgeting for seasonal expenses. If you want to save up for holiday expenses, make sure you add a “Holiday expenses” line to your budget for August through December. Doing so will give you time to save up what you need for presents, parties, and other expenses. 3. Subtract Your Expenses From Your Income Once you subtract your expenses from your income, you’ll have a better idea of if you’re living within your means or taking on more debt. If your income is higher than your expenses: You have money left to save or spend. Consider putting some of this money toward the financial goals you set in Step 4.If you broke even: You’re living within your means, but just barely. Ideally, you want some extra money left over each month to put toward your financial goals. See if there are a few expenses you can trim to give yourself a buffer to work with each month. If your expenses are higher than your income: You’re spending more than you make. Look for ways to trim expenses or increase your income. 4. Build Some Financial Goals Into Your Budget As you build out your budget, incorporate some financial goals you’d like to reach in the coming months or years. For example, you could create budgeting categories for goals such as: An emergency fundDown payment on a houseSecurity deposit on a new apartmentNew carVacationKid’s college fundExtra debt payments 5. Make Adjustments as You Go Your life is dynamic and constantly changing, so your budget should be, too. When you get a new job, add a new expense, or earn a bonus, adjust your budget to reflect the changes. As you move throughout the month, track your spending and make adjustments as needed. If you consistently overspend in one budget area, you may want to move money from another spending area to cover the difference. “There is no one perfect way to budget,” Weiss said. “It's important to go in with the expectation that budgeting is a skill that takes practice. You'll likely fail in month one, but what's important is you take what you learned and apply it down the road.” Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Consumer Financial Protection Bureau. "Building Blocks Student Worksheet: Learning About Budgets," Page 1. Accessed Jan. 11, 2021. Young Leaders of the Americas Initiative. "Top 4 Budgeting Methods To Try." Accessed Jan. 11, 2022. Part Of Key Budgeting Terms What Is a Budget? What Is a Balanced Budget? What Is a Budget App? What Is Disposable Income? What Is Net Income? What Is Debt? What Is a Zero-Based Budget? What Is a Pay-Yourself-First Budget? What Is a Debt Repayment Plan? What Is Net Worth? What Is Lifestyle Inflation? What Is the Life-Cycle Hypothesis? What Is Consumption Smoothing? What Is an Automatic Bill Payment? Related Articles How Should I Start To Budget? 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