Most think of budgeting as writing down income and expenses on paper and then checking whether the result fits our wallet reality. For many, it doesn’t, but it’s not obvious why. The value of budgeting is not only in getting an accurate picture of our finances today but also to use that picture to determine what needs to be done to put our finances on the right track for tomorrow.

You might also think the first step in budgeting is to put the numbers on paper, but I believe the first step is to focus on why you’re doing this. Budgeting helps balance your life with your finances. You do this to avoid debt, save for the future, reduce the risk of an emergency, and live with less stress. First, know what money problem(s) you’re trying to solve. OK, the second step is to choose a method for creating the budget. I prefer the spreadsheet approach on your home computer or laptop, but you could use a phone app or a pad of paper. I use spreadsheets for their flexibility, quick answers, and ease of recording and updating the plan. It’s low-cost, and you’re not paying a monthly fee or creating yet another login. So, find a simple spreadsheet and get ready to start. Note: There are dozens and dozens of spreadsheets out there (including those for purchase here), some of which do more than just a budget and provide fancy graphics. Some will roll up individual expense lines into major categories like housing, utilities, and transportation, which isn’t necessary. You only need to start with a basic one.

While you can do monthly budgeting by creating a new budget each month, I prefer an annual budget because it’s better to see your finances across the entire year. An annual budget puts monthly, semi-annual, and annual expense amounts in context because you’ll see the annual totals. You also need to decide how detailed to break down expenses. Does “food” include eating at home and eating out, or should they be separate? Should the food expense include cleaning supplies and paper goods? My advice is not to go too detailed; 25 to 50 expense line categories are sufficient. Begin by entering the income and expense amounts. Don’t just guess; find the last bill or average the past year’s expenses, for example. This is key. You can’t just guess that Electric will be $100 a month and Food $450, because over the past year, you probably have evidence that Electric averaged $125 and Food $525, which makes a big difference over the course of the year.

Once your initial budget is complete, you’ll look for the “bottom line.” Are you under or over budget? I recommend a good budget be at least 2% under for the year. This provides a cushion for higher expenses or erroneous estimates. What to do next depends on the result. Way over budget? Go back and review your entries. Maybe there’s an error. If it reflects your reality, because you’re short every month, the next step is to do the work to reduce or eliminate expenses. If you’re about balanced, what changes could you consider to increase emergency or retirement savings? Regardless of the bottom line, check and recheck your numbers and confirm that what you have documented is accurate. One caution: keep it simple. The more detailed you make your budget, the more frustrated you’ll get with the effort and not stick with it. If you’re over budget, the budget can help identify where the problems are, but the solution lies in controlling spending, not the budget itself.

Another benefit of the annual budget is goal setting and expectation management. If I have an expense line for “Entertainment” of $1,200 for the year, I can’t keep agreeing to go to a concert every time someone asks. Trying to save 8% for retirement? Including the monthly or quarterly amount in the budget helps force the savings; otherwise, we’ll realize we’re spending more somewhere else, which is why there’s never money to save for retirement.

The final step is to use your budget regularly to manage your money better. In the example above, review your entertainment spending throughout the year and decide whether you’ll hit your goal. If not, can higher spending in one area be offset by lower spending elsewhere? Correct the path you’re on before it’s too late. I review my spreadsheet budget at least once a month and adjust it every few months to reflect changes in spending or plans, always making sure to stay balanced at the end of the year. I’ll check it before committing to any large expense. I also review the list of expenses to identify ways I can spend less, get better deals, or even eliminate some expenses. Plus, this regular attention allows you to consider time frames: will the car be paid off this year? If so, can we now afford X per month for junior’s braces? Laying out the expenses throughout the year becomes your plan. Budgeting is a process that becomes a good financial habit for staying on track. So, take an action for yourself to make a complete and accurate budget and then use it throughout the year as a step toward a better financial outcome.

Read more about budgeting in What Would Dad Do? - Volume 1: Essential Money Management