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Now on to Step Two of Creating a Budget.

If you have followed the first part of this series you have reviewed your expenses from the last couple of months and categorized them for easy organization.

I personally utilize a Zero Based Budget. This means that I spend all of my money on paper prior to the month beginning.

No excuses – everything is allocated into a category.

If you have extra money you are missing the point. Every dollar has a purpose. For us, any extras are added to either debt reduction or savings.

To set up our budget, I first look at the upcoming month and make an estimate of our income. Aaron and I both have a regular salary and then some incentive based income. For our budget, I’ve chosen to only use the regular salary numbers. I’ll discuss the extra income later.

I set up my Zero Based Budget by taking the following steps:

1.  Review previous 3 months of spending

How to create a budgetI use Quicken, (which I highly recommend) so I can easily run a report showing exactly how much I spent on each category. If you are not using some form of electronic tracking I highly recommend at bare minimum using Mint or some other online free tracking program.

Your categories will probably vary from mine, but for ease of use, I typically include household items like cleaning products in my grocery budget. When I eat out for lunch I include it in dining out, but if I bring my lunch I consider that part of my grocery budget.

Find a way of categorizing expenses that works for you. I’ve spent years trying different budgeting methods before finding a system that works for me.

I do recommend watching the little things. If you are getting a $5 coffee each day you may want to start tracking it individually. Sometimes those little items can really add up.

2.  Average out the discretionary spending accounts and fun accounts

How to Create a Budget

I already know the average of my fixed costs, so I separate out the expenses that change month to month and average these numbers.

I also review my past spending for any anomalies that may affect the numbers. For example, Aaron and I typically travel every couple of months, so I want to make sure and include a high travel month in my spending so I don’t under allocate.

3.  Review Annual/Quarterly expenses and allocate a set monthly amount

How to Create a Budget

For this category, I review the previous year’s numbers and base my calculations accordingly.

We have four cars and a boat, so our car maintenance numbers are typically higher than the numbers above. We have minimal health costs, so our Co-pays may be lower than normal.

The important thing is to include all of the miscellaneous annual expenses.   These expenses are typically higher than normal and can blow your budget.  I’ve got a great post about when I completely blew my budget if you are interested in some of my mistakes – I make a lot of them.

I always add $500-1,000 to this category. It doesn’t matter how often I budget; I always forget something. This is my cushion money for those oops moments.

4.  Review upcoming month’s schedule for irregular events/expenses

I always take a quick look at my calendar for travel, parties, birthdays and school costs. I’m just looking for anything out of the norm that may cost me extra money.

If I’m going to be traveling I need to adjust my gas, travel, food and entertainment categories accordingly. I also adjust my utility numbers based on the seasons.

5.  Allocate a set dollar amount for every potential expense

How to Create a Budget

Once I’ve reviewed everything I’m ready to actually put in dollar amounts.

6.  Total all expenses and then roll up individual totals into five categories

How to Create a Budget

Once I’ve totaled everything I drop my expenses into one of my five categories. This isn’t a necessary step, but personally, I feel like it makes budgeting so much easier.

I really struggled with budgets that were 30-40 lines long and included all kinds of expenses. Once I started using the KISS theory budgeting became significantly easier.

By rolling up the numbers into 5 categories I also have the flexibility of switching stuff up as the month progresses. This year I’ve had to do a lot of business travel which meant more business clothing. I over spent my clothing budget one month, but spent less on entertainment, keeping my Fun Spending in-line.

If you have extra money after totaling everything, go back to the budget and make sure it gets categorized. If you are short on funds (which is the norm), then you need to cut costs.

I review my discretionary expenses first, cut out the fun stuff and then work my way down the list again. At this point, you have to go back to my Two Unbreakable Rules for Budgeting.

7.  Meet with Spouse to go over budget and review numbers for accuracy

If you are single you can skip the last step (obviously), but if you are married, the last step is crucial.   A budget will not work unless you are on the same page as your spouse.

If you are married, you must review the budget together and make adjustments based on both party’s wants and needs.   If something comes up in the middle of the month and adjustments need to be made then you must meet together to decide what will be cut.

My kids occasionally forget to mention school costs (they don’t take my budget as seriously as I do), the car will break down, the water heater will go out, or the power bill will be higher than expected.

Something will always happen that is going to throw you off your budget.   When this happens you must be committed to living within your budget.

If the money isn’t in the budget, then you do without until you can reallocate the money.

If it is a major expense then you dip into your emergency fund.


Don’t expect your budget to work perfectly the first month, the second month or even the third month. I’ve been budgeting for years and still have a lot of room for improvement.

Don’t get bogged down in the details. Find a system that works for you and most importantly keep it simple.

Personal finance is more about attitude and behavior then it is about actual knowledge. You can have all the knowledge in the world, but if it is unapplied then you are wasting that knowledge.

In order to do a budget, you must have self-control. Unless you actually follow your budget it is just a wish list.

If you are interested learning more about this subject I highly, highly, highly recommend anything by Dave Ramsey. His book “The Total Money Make-over” is one of the best resources on the market for managing your personal finances.

I’ve still got a few additional post to do in this series including one on debt reduction, emergency funds and cutting costs.

***Shortly after I wrote this post my husband’s company went out of business.  Fortunately, we had just completed our 6 month emergency fund and had paid off $293,000 in debt.  I wrote a post How We Paid Off $293,000 in Debt in Five Years that talks about our experience. We couldn’t have accomplished this without making and sticking to our budget.