This past week I was on a call with a Debt Free for Life client. She was asking me how to create a budget when her income was not so steady, freddy. In financial lingo – this is called variable income.
Let’s be real, it’s pretty easy to set up a budget when you know exactly how many dollars you are going to bring in each month. (The not-so-easy part is sticking to it.) So, what do you do if you’re a:
Paid on commission (I cannot, cannot, cannot say that line without thinking of Pretty Woman)
Or in the case of my client, her hours frequently get cut. She can’t always rely on a 40 hour week. This week, I’m dedicating my post to answering her question….
How To Budget When Your Income Changes
Step 1: Start at the Bottom and Calculate Your Baseline Expenses
The budget creation process and most budget templates begin with total income. When your income changes month-to-month, or week-to-week, heck even day-to-day, it doesn’t make sense to start at the top. Instead, start with your expenses.
- Make a list of all your expenses, using the minimum payment required.
- If you have any expenses that fluctuate monthly, force them flat. In other words, calculate an average. In step 4, we’ll talk about what to do when you receive your bill and it’s over or under your expected average.
- Tally up your total expenses. That, my friend, is your minimum baseline.
- It’s helpful if you have a good idea of what all your expenses are. If you’re a member of The Light, you received a free copy of my Daily Expense Tracker. If you aren’t a member, well first you need to join at the bottom of this post. Second, you can purchase a copy in my Etsy Shop for a small fee. This is a great tool to finding out the truth behind where your money really goes. Because it never goes where you think it should. Right? Yep! All right, let’s carry on.
Step 2: Calculate Your Fixed Income
Now that you have your expenses nailed down, it’s time to hammer on your incoming cash. At the end of the day (such an overused saying, I know, but I love it anyways) you need to fix your income. The simplest method is to calculate an average based on a rolling twelve month period.
You guys, my client – she is so inspiring. She is working her booty off to get her finances in order. She’s got a rock wall ahead of her, but she’s got her safety harness on and she’s started her climb. As soon as she gets to the top, debt is going to come tumbling down.
Because I was so inspired by her, and because this is a post dedicated to answering her question, I created a worksheet for her. And you my friends, you get to benefit. Yay you. (The worksheet will be available for download for the next 30 days. And it’s for personal use only, okay.)
- To calculate your fixed monthly income, identify a 12 month period. Oh say, August 2012 to July 2013.
- Grab the shoe box from under your bed. You know the one where you toss all your (important) financial documents. Write down your total income for each month in the corresponding boxes. So, August 2012 = One. September = Two. And so on.
- At the bottom of the worksheet, total your annual income, divide by 12. Voila, you have your fixed monthly income.
Step 4: Plug the Gaps
This is the not-so-fun part. You’ve been warned.
- Using your preferred budget method – Mint, Quicken, Excel, back of a napkin – you’ll need to enter your income and expense. Ideally your income will exceed your expenses.
- If not, you’ll need to wiggle and jiggle and wiggle some more, until everything balances out.
- Remember, the expenses are your minimum baseline, so if you need more income, here are a few ideas. Or you can google to your hearts content on how to earn additional income.
- I mentioned in step one above to fix your expenses that fluctuate every month (perhaps your electric bill). In a similar manner you calculated your fixed income, calculate the fixed amount of your electric bill (or whatever bill). On the months that your bill is less than your budget, keep that money in your account. Treat it as a reserve. You’ll use it a later month when your bill is more than your budget.
Step 5: Pay Yourself a Salary (The Key Step)
One of the temptations of an income that changes monthly is to overspend on the good months. Then when the bad month inevitably circles back around, you’re doing the moonwalk in your Michael Jackson wig trying to earn a few benjamins. So! Pay attention here – this part is important. You are going to pay yourself.
- You’ll need two primary bank accounts – we’ll call these Bank Account A and Bank Account B.
- The first account (Bank Account A) is where you’ll deposit all your income. So if it’s from a traditional employer, they’ll direct deposit your paycheck to that account. If your self-employed, this is where you’ll deposit all your client receipts. Even that $1.89 check from the class action lawsuit you didn’t even know you were part of – that check goes here too.
- On a pre-determined date, could be once a month, twice a month, or weekly if you like – you’ll transfer the fixed income you calculated at step 2 from bank account A to Bank Account B. Tada – you’ve just paid yourself.
- On the months that you make more than your minimum baseline, you’ll be building up a reserve to use the months you make less than your minimum baseline. Ideally, you’ll have more months where you make more and then you’ll have to make a decision…. What to do with all that extra money!