Explore the importance of budgeting as a foundational step towards financial literacy. By dissecting the four main components of a budget—net income, fixed expenses, flexible expenses, and discretionary expenses—we unveil the roadmap to better money management.
Warning: This post may contain math!
Building a budget is the first step toward becoming a better money manager. Believe it or not, many people don’t know how much money they earn or how much they spend each month.
That’s why we create budgets. Budgeting is a financial exercise that sometimes surprises people—even shocks them when they discover the amount they spend each month. It also inspires them to change their financial habits. Before you break out the calculator, know these four main components of a budget. This will allow you to get all your paperwork in order before diving into equations and spreadsheets.
1. Net income
Net income is the income you take home from each paycheck. It is your wages minus taxes, retirement contributions, employer-sponsored healthcare costs, etc. If you’re married, it also includes your spouse’s wages. It also includes money you earn through investments, a part-time job, and even alimony.
It’s essential to include everything to maintain an accurate budget. You should also report the income you actually receive and not the income you expect to receive. For example, if you are supposed to receive child support but do not receive payments regularly, do not include this in your income.
2. Fixed expenses
All expenses are not created equal. You need to separate them into three categories to reveal where your money is being spent and pinpoint where you can cut spending if necessary. Fixed expenses are usually necessary expenses and remain fixed from month to month. They include car payments, mortgages, rent, and even expenses such as HOA fees. Basically, if you can’t change what you pay each month, then it’s a fixed expense.
3. Flexible expenses
As the name suggests, these expenses are flexible in how much they cost. They change monthly but are mostly necessary – although you can easily lower them. They include grocery bills, utilities, cable, and cell phone bills.
4. Discretionary expenses
These are your wants. Discretionary expenses are items you don’t necessarily need to survive but still buy them anyway because you want them. These include gym memberships, dining out, morning coffee, and more. They may also include unexpected costs, such as home repairs. When you’re creating a budget and need to reduce expenses, these are the first to get cut.
Start building your budget
Now that you know the four components of a budget, you’re ready to start adding and subtracting your way to a better financial lifestyle.
Many credit unions offer free financial resources, including worksheets, interactive courses, publications, videos, and more, to help you take control of your financial future. Join a credit union today!