If you’ve decided you need a budget, most people tend to advise a very similar process to arrive at a budget. My approach is fairly similar, but I’m a strong believer in keeping things simple, and so my process tends to keep the process as high level as it can be, but allows you to dig deeper into the “problem” areas wherever it is needed.
The purpose of a budget is to understand what your “personal profit” is each month, based on your existing spending patterns and income, and then using this to create a target for what you think you should be achieving.
Personal Profit = Income Minus Expenses
The below runs through how I approach budgeting manually, using a spreadsheet software like Excel or Google Sheets.
You can do this the old-school way with a pen and paper, or (I would recommend) firing up a good old spready such as Excel or Google Sheets and put down the following headings. These headings do me just fine and should mean that you won’t spend too long coding everything up:
- Income (if you have more than 1 stream of income, split out under this heading)
- Expenses (with subheadings as below)
It is crucial to understand that some of these costs are fixed, and some are discretionary. This will become more important later on. For example, Rent/Mortgage and Utilities are fixed – you need them in order to live in a house/apartment and they are normally fixed in place by a time-limited contract. If you travel to work via a car, then a car is deemed essential but not fixed. Entertainment and Holiday however will be deemed discretionary. These are items you can cut back on if you need and are also completely variable i.e I won’t have a beer this week, I won’t buy a new shirt this month etc etc.
Of course if you would prefer to have more granular accounts (such as splitting Entertainment into both “Eating Out” and “Entertainment”) then please do so. Arguably the more granular the better, but more accounts will mean more work when tagging up transactions.
My Budgeting Process
- Work out historic spending/income levels
- Find pain-free savings
- Rebudget, using these pain-free savings
- Find more painful savings (if needed)
What do I need?
In order to run this process, you’ll need:
- last 6-12 months worth of bank statements
- last 6-12 months worth of credit card statements
Work out historic spending/income levels
To find out your last 6-12 months spending, you will need to run through your bank/credit card statements to tag up each transaction with one of the above category codes.
For any transfers between accounts, simply tag this as “Exclude”. Transfers between your accounts we aren’t interested in as that money isn’t being spent externally.
If you’re paying off your credit card, you want to tag the transaction in your bank account as Exclude. This is because we will be recognising the original transactions in your credit card statement with the relevant category as it gives us more detail. For example, you spend £100 on your credit card on “Groceries”. You tag up that transaction as “Groceries” in your credit card statement. You pay off the £100 with your bank account, which comes up as a transaction on your bank statement. You tag that transaction as “Exclude”, because you are simply “transferring” money to your credit card to pay off the original £100 transaction. You don’t want to also tag that transaction in your bank account as “Groceries” also, as otherwise you will be double counting and will make your financial situation look worse than it really is.
Start by running through your bank statements and tagging any income lines with “Income”. If you have more granular income account codes, then tag it up appropriately (for example if you want to track your “interest income” separately to your “freelancing income”, separately to your “employment income”).
It is better to run through your bank statements for this rather than rely on an estimate, as a 6-12 month average of this is a much better indicator of your actual income as it is what you have actually received. This is especially easy if you are employed and receive your after-tax income into your account.
If you are self-employed or receive income that you need to pay tax on, use the tax calculator to try to work out the amount that is after-tax to include. If you include the full amount, then you’ll need to make sure you include an estimate for paying tax (as otherwise that will be a nasty surprise down the line).
Once you have tagged up all of the transactions, simply add them up and include in your Excel under the heading “Income”.
Follow the same process, running through your bank statements and coding up each transaction to the relevant code (remember to exclude any transfers between accounts).
Once you have completed that, add up each category and put the total into the relevant box on your spreadsheet.
You will now have a total 6-12 month total for each category. Now, I find it very useful having an average monthly view as well, so in the column next to your “totals”, just add a column for “Monthly Average”. Here, take the totals and divide by the months you have data for (i.e if was last 6 months’ worth of data divide by 6, or if it was for the last 12 months’ worth of data divide by 12), and you’ll have a monthly average.
This is useful because it will tell you what a typical month looked like in the last year and includes one-off items like car repairs and holidays.
Now, run another simple calculation which is the total income minus the total expenses to find out your “Personal Profit”.
Is your Personal Profit more than 0?
Good work! You’re already doing well than most of us. By default, you’re living within your means and managing your money well.
That doesn’t mean that there isn’t room to improve though, so I would recommend combing through your fixed costs and seeing if there are any areas you can make some pain-free savings on any of your regular payments;
- look for subscriptions, do you still use these? If not, axe them. No pain, but money back in your pocket.
- check if you can find a cheaper provider for your utilities bills (gas, electricity, phone bill, insurance, TV, internet etc) – jump onto a price comparison website and see if you can save easy £££s there
Want to ratchet up your savings rate? Then the advice below will also apply to you, as these include some more painful savings than mentioned above.
Is your Personal Profit less than 0?
At least now, you know! This will now make sense why the credit card balances are increasing, and you live paycheck to paycheck.
The good news is, now that you know, you can make some changes to switch it into a positive. The aim is to get your Personal Profit back into the positives, so that each month you have money left over that you can use to do anything that builds your net worth (and by this it could be paying off debt, saving, investing etc).
First, lets look at some pain-free ways to save money where you can really turn the needle.
Repeating transactions are the ones you want to focus on first. If you can move the needle on these, then this saving will repeat itself each and every month. A saving of £50 per month in aggregate between all of these can equate to £600 per year which might be enough to move your Personal Profit back into the positive, and so don’t sniff at these ideas!
The ultimate pain-free saving. Pay less for the exact same usage, no change in lifestyle needed. Jump onto a price comparison site and search for cheaper deals on your gas, electricity and water bills and simply pay less. Boom, easy peasy. This will probably take you 30-60 minutes, but is likely going to be the best hourly rate you’ve ever earned. Make sure you do this on a regular basis (maybe every 6 months or every 12 months dependent on the contracts you’ve signed up to) to make sure that you aren’t missing out on the best deals.
Do the same for your insurance too. Speak to a financial adviser if you are unsure whether your insurance is still relevant for you, and cut any that are superfluous to your needs (or alternatively, taking out insurance to mitigate a risk you’re worried about is never money poorly spent in my opinion).
Subscriptions (variable, but anywhere between £50-500 per year saving)
Depending on the subscriptions, these can be completely pain-free to painful as sin. If you’ve had some random subscriptions build up, bin them off ASAP.
These are so easy to build up, and a couple of quid here and there easily lulls you into the sense that they won’t move the needle but I promise you they will. Look through your subscriptions / repeating transactions and ask yourself whether you actually get any value from these. Do you regularly use your Netflix account enough for it to be warranted? Could you not just get “good enough” TV using freeview? Remember that 5 £7.99 subscriptions per month is nearly £500 per year.
The more painful version of this is cutting out the things that you do use and do like. If you love watching Netflix, then I would suggest keeping it as-is (maybe try moving to a lower tier) and try the other options here first. If your Personal Profit is still negative, then unfortunately it is time to get brutal and start cutting these sorts of spends. You can definitely live without Netflix, and the saving will be worth it.
Phone Bills (~£300-600 per year saving)
Once again, dependent on your wants and needs this could either be completely painless or fairly painful. Is your phone contract coming up for renewal? Consider holding out and not renewing, keeping the phone you already have and simply switch to a super cheap SIM only plan. This could easily save you £40+ per month dependent on the previous contract you were on. Cheap SIM only deals with bags and bags of data you can get for less than £10 per month! Most handsets will last longer than the 2 year standard contract length, and it breaks you out of the merry go round of upgrading your phone every 2 years, especially now that the technology is so good it isn’t going to become obsolete in 2 years’ time.
Now, do a re-check of your Personal Profit by rebudgeting
Now that you’ve made those cuts, copy your “average monthly” column to a separate column on the right. You can label this your “budget”.
Now that you’ve made those cuts, lower the relevant categories based on the cuts above i.e if you reduced your phone bill from £50 per month to £10 per month, change the relevant category.
Now, is your Personal Profit positive? Good work, you’re back in business. You can now continue reading to make some more painful cuts that will supercharge your finances and allow you to save even more towards your goal.
Or, if your Personal Profit is still negative, we need to get a bit more brutal. Next up are the painful cuts.
These are the areas that cover discretionary spending that we discussed earlier. This will mean cutting back on the fun parts of life, and why I include these under the “painful cuts” section. If you find that you are spending too much money eating out for dinner, drinking with friends, buying new shoes or going on holiday too often, these are the next targets in your quest for an improved financial situation.
You will know best what areas you need to cut back on, but there are loads of ways that you can replace an expensive pastime with cheaper alternatives.
For example, instead of going out to a restaurant for dinner, organise a dinner party round robin each week like Come Dine With Me (albeit hopefully minus the passive aggression and dodgy entertainment).
These are areas where I’m not going to run a load of suggestions past you, as you will know best the areas you need to cut back on. There are countless articles online dispelling the best frugality “tips” and “hacks”, so I won’t repeat them here.
There are areas that can really move the needle but are very painful (potentially). The large, repeating transactions. These are normally the ones that people are hesitant to change, as there tends to be inertia there and fairly big lifestyle changes.
Do you lease a car or have a loan to pay off on a car? Not much you can really do about it at the moment as you’re likely signed into a contract with hefty exit clauses. However, start to manage your expectations around the renewal just like you did with your phone contract. Do you really need a new car every 2-3 years? Monthly car payments can easily be £100’s, and you’re normally better off buying a car that you then own, and letting it run for as long as you reasonably can.
If you end up commuting to work really far away, this is an absolute money drain (unless they reimburse you for the travel expenses).
This is where the decisions get harder, as if you either moved house closer to your job (if the housing stock around your job is good value), then moving closer will allow you to either cycle, walk or take public transport that will most definitely be cheaper (but run the maths).
Moving to cheaper housing is the biggest lever you can pull to change your financial situation. Now this is obviously a big decision so make sure you’ve analysed it thoroughly (taking account of any one-off moving costs and the impact on your travel costs), but generally moving to a smaller place will unlock potentially £100’s per month. Being more drastic and moving to a completely different place where the housing is a lot cheaper (but still provides you cheap travel, say, if your job is still close by) may unlock even more.
Try not to be trapped in the mindset of keeping up with your peers or neighbours. If your financial reality is showing you are making a Personal Loss each month (instead of a Personal Profit), then you shouldn’t be keeping up appearances. Without sounding fatalistic, doing so has the potential to send you into a debt spiral, where you take on more debt to pay for your lifestyle that you can’t afford, and then taking on more debt to pay off the debt you took out in the first place, all the while this extra debt increases your Personal Loss each month even further due to the interest payments, which accelerates the spiral into debt even further. The ultimate ending to that kind of situation without help is essentially bankruptcy.
But the reason you’re here shows that you’re willing to take control, engage in your finances and take the right steps to improve them, so I believe in you!
If, after putting in place the different levels of cuts as above, you still find yourself in a position where you can’t cover your monthly outgoings and you have high levels of debt building up, I would suggest you reach out to advisors for professional help. There are many organisations who can advise and help you work through the best options available to you, and be assured that there are options. I would recommend using the free, not for profit debt crisis agencies such as:
I now have a budget, what next?
You hopefully have a budget that gives you a Personal Profit, i.e your income is now higher than your expenses and it gives you some leeway each month.
Now you need to stick to it in order to reap the rewards and start paying off your debt/build up savings/invest/whatever goal you have.
There are many different techniques to keep you on the straight and narrow of sticking to your budget.
The one that works best for me is a mixture of the Envelope method, and Paying Yourself First.
Paying Yourself First
If your budget says that you have a Personal Profit of £200, then once you’ve been paid literally pay yourself first by transferring £200 into your savings account, or to pay it into the debt you are paying off. This means that you haven’t even seen/noticed this amount and therefore cannot spend it.
With the remaining money, I transfer my money into separate accounts so I always have an accurate snapshot of what I have left to spend. This means you don’t need to track the money in/out of your account to understand how much you have left to spend on random things.
This is much clearer than keeping all of your money in one account, but having to work out each time how much is actually left for you to spend as you have rent payments, bill payments etc still to come out. The envelope method essentially puts the money into separate pots for separate purposes, keeping everything compartmentalised based on its use.
I transfer my budgeted amount to a House/Bills account that pays for my rent and bills automatically via direct debit/standing order. Once it is in there, I know not to touch it and I know that it will be paid automatically.
Next, I transfer my budgeted amount to a holiday account, once again this is kept separate and builds up over the year.
Next, I transfer my “Entertainment”, “Groceries” and “Travel” amounts to a separate current account that I use for all of my discretionary/travel spending. This is the only card I carry around with me. This means that I know all of my bills are being paid for, and all I need to do is check my spending account to see how much I have to spend on random stuff. That way I don’t need to track my spending to know how much I have left to spend. I actually take it one step further and drip feed this account with weekly increments (tries to discourage me from spending the whole month’s amount in one week!).
Another method that is quite useful for this is to take your weekly spending amount out in cash, as having it physically in front of you acts as a strong psychological cue to limit spending if you can see it dwindling faster than it should be.
I found the cash method to be too restrictive personally as not every place accepts cash anymore, and you have no way to track what you’ve been spending on if you wanted to (unless you’re super organised and carry your receipts).
The feedback loop
It is important to check in regularly (especially at the beginning), to compare your actual spending with your budget. From here you can make further lifestyle choices to make sure you hit your budget, or you can adjust your budget.
Remember, the goal is still to maintain and to increase your Personal Profit. A higher Personal Profit means a faster path to your goal, but may mean more short term sacrifice. By being engaged in the process, you’re going to know when to push harder or ease off.