How to make a budget

Published by Emma Lunn on 07 March 2017.
Last updated on 01 June 2018

According to the Money Advice Service, more than half of UK households keep a regular budget and most say it gives them peace of mind about how much they are spending.

But what does ‘making a budget’ actually mean? Listing income and outgoings? Setting savings goals? Tracking where every penny goes?

There is no one-size-fits-all answer. What kind of budget, or budgeting technique, works for you will depend on your financial circumstances and goals.

Moneywise has taken a look at the different methods of budgeting and the assortment of apps and websites that can help.

Budget technique 1

Income vs outgoings

Many people have no idea how much money they have coming in each month and where it all goes. So listing income and outgoings can be a good place to start your budget.

Your income will include your salary, any benefits or tax credits, plus income from savings and investments. Outgoings include your rent or mortgage, household bills, council tax, commuting costs, variable essentials such as food and toiletries, and ‘fun’ money. If you’re in debt, you also need to factor in debt repayments.

There are several online tools that will help you work out your income and outgoings.

Citizens Advice’s budget tool allows you to state whether the outgoings are weekly, fortnightly, monthly, quarterly or annually, and helps you plan for the expense accordingly. National Debtline and MoneySavingExpert.com both offer similar tools.

“At National Debtline, we ask that people complete a monthly budget that accounts for all their incomings and outgoings, and any additional one-off expenditure they may have such as car insurance or road tax,” says Nic John, information officer at the Money Advice Trust, the charity that runs National Debtline.

“To put together an effective budget, we encourage people to be realistic about their spending by looking over their bank statements and receipts.”

Next, it’s time to look at how your income and outgoings measure up. Have you got money left over each month or is there a shortfall?

“Some people may have a problem with their income level, so we advise them to check their benefits entitlements,” says David Rodger, chief executive of debt advice charity, the Debt Advice Foundation.

“Others may have an issue with their levels of expenditure and will need to enforce some lifestyle changes. This can be reducing areas of spend on non-essential items that people often don’t think about, for example their TV package, bank account charges or paying council tax over 12 months instead of 10.”

Budget technique 2

Track spending

For many people struggling to make ends meet, it’s not their household bills that are the problem – it’s frittering money away on a daily basis and not understanding where it’s going.

Research by insurer Royal London found people who monitor their everyday spending are more likely to make beneficial changes to their spending behaviour.

A sample of Royal London customers were given smartphone budgeting apps (or a pen and paper equivalent) to use for a three-month period. Of those who tracked their spending for the whole three months, half said using a budgeting method was helpful in monitoring what they spent.

Steve Webb, Royal London’s director of policy, says: “What was interesting about our research project was the way in which the simple act of monitoring what you spend every day or week made some people more aware and put them more in control of their finances. They were then able to make their own choices about priorities.”

It is easy to track your spending by recording transactions on a spreadsheet or with a pen and paper, but technology can give you a clearer idea where your money is going.

Desktop and app-based tool, Money Dashboard, for example, allows you to securely connect all your online accounts, and all your transactions are automatically pulled into the dashboard and categorised.

Jossie Ellis at Money Dashboard says: “You can see at a glance how much you've spent in a month on anything from food to travel to going out. You can also look ahead, using our budget planner tool to proactively control your spending and saving and to set your own financial goals. Transactions and balances are also refreshed automatically every day, so you're up to date with your current financial position at a glance.”

Budget technique 3

The envelope method

Looking at your bank balance often doesn’t give you a clear picture of your finances, as it doesn’t show when payments and direct debits are due. This causes many people to splurge on payday, but then struggle later in the month.

This is where the envelope (or ‘pot’ or ‘piggybanking’) method of budgeting comes into play. You take your monthly income, divide it into different categories, and aim to stick to your limit for each category.

For example, you might allocate £500 to rent, £200 to food shopping, £50 to clothes and £100 to eating out. Whenever you spend money, it needs to come out of an ‘envelope’ and you note how much you have left. You’ll need to be realistic and disciplined – when the money in an envelope is gone, it’s gone.

In theory, you could actually do this by putting physical cash in different envelopes or pots, but it is much more practical to do it on paper or digitally. By tracking your spending, you can check your bank account less often and concentrate on what’s left in each virtual ‘envelope’. Smartphone apps such as You Need a Budget and Good Budget provide digital envelopes and do the maths for you.

Budget technique 4

Tackle debt

If you’re in debt, sticking your head in the sand is a dangerous tactic: your ultimate goal should be to be debt-free and this won’t happen unless you take action.

“The important thing when dealing with debt is to act quickly. Over half of our clients say they waited over a year between worrying about their debt and taking debt advice,” says a spokesperson from debt charity StepChange, “If you’re struggling to keep up with the regular payments to your debtors, your borrowing is going up each month, or you feel your debts are getting too large and difficult to manage, it could be a sign that you need free debt advice.”

Before you speak to a debt adviser, get all your paperwork together and work out the total amount you owe and to whom. This should include any mortgage or rent arrears and overdue bills, as well as credit cards and loans.

A debt adviser will help you prioritise your debts and include affordable payments in your monthly budget. In some cases, they may recommend a debt management plan (DMP) or an individual voluntary agreement (IVA) – a legally binding repayment plan. 

If your debt situation isn’t so bad as to warrant advice, you should aim to switch your debts to products with lower interest rates wherever possible, such as 0% balance transfer credit cards. This will enable you to pay off your debts quicker and pay less interest overall.

Budget technique 5

Multiple accounts

Many people swear by having a separate current account set up specifically for paying bills. To do this, use a budget planner to work out how much both your monthly and annual bills come to. Divide the annual amount by 12 to get the monthly figure: this will give you a total amount to pay into your ‘bills’ account each month.

Set up a standing order for this amount for the day after payday, and arrange for all your bills to be paid by direct debit from the new account.

Don’t do any further spending from your ‘bills’ account; the rest of your income remains in your existing current account for day-to-day spending.

If you need to open a second account for bills, pick one that offers cashback on bills such as NatWest’s Reward Account or Santander’s 123 current account.

A good budget should also include contributing to a savings account each month if possible –  this should be transferred shortly after payday.

“Many people try to save at the end of the month, hoping there is enough left after bills and spending. The problem is, there usually isn’t money left – when we consider it available, it will be spent,” says Jamie Smith-Thompson of pensions and Isa advice specialist Portafina.

“To overcome this, pay yourself first. You can put the money into an easy-access account, so you can use some of it if absolutely necessary, until you adjust to having less to spend.”

Five of the best budgeting apps

Good Budget

Good Budget is an app that takes the envelope approach to budgeting and makes it digital. It allows users to plan, not just track, their spending, based on amounts in designated digital envelopes.

It also allows couples and families to synchronise their household budget across different devices.

Works on: Android, iOS, Web
Cost: The basic version is free. The ‘Plus’ version costs $6 (£4.50) a month or $50 (£37) a year

Money Dashboard

Money Dashboard aggregates account information from all your current accounts, credit cards and savings accounts in one place. Transactions are tracked daily so you can see exactly where your money goes and how much you have left each month after all your bills have been paid. It also includes a range of tools help you organise your finances more effectively as well as plan for the future.

Works on: Android, iOS, Web

Cost: Free

Pariti

Pariti offers read-only access to all your accounts on one platform. Automatic updates allow you to see exactly how much money you have whenever you open the app.

Pariti automatically forecasts your upcoming income and bills to calculate how much you can afford to spend each week and provides proactive warnings to help you stay on track.

Works on: Android, iOS
Cost: Free

Spending Tracker

Spending Tracker offers a user-friendly way to track every penny you spend. Spending is split into categories with bar charts and graphs, income versus expenses, plus weekly, monthly, and annual totals.

Works on: Android, iOS, Web
Cost: The basic version is free. The ‘Pro Upgrade’ with more features costs a one-off fee of £2.99

You Need A Budget (YNAB)

YNAB has received some rave reviews in tech circles. It’s not purely an app, but desktop software with a companion app. It uses the ‘envelope’ method of budgeting and its mantra is ‘give every dollar a job’ (it’s American, but you can work in pounds).

The app allows you to enter transactions on the go, check your category balances before making a purchase, allocate debt repayments and plan for annual expenses.

Works on: Alexa, Android, iOS, Web
Cost: Free for 34 days (12 months free for students), then $83.99 (£62.63) a year

‘It’s changed my spending habits and changed how I think about money’

Matthew Hurst, 33, an administrator from Kingston Upon Thames in London, used the Spending Tracker app for three months as part of a YouGov survey for insurer Royal London.

“It’s changed my spending habits and changed how I think about money. I used to spend it on things I didn’t need, such as takeaways and trips to the canteen at work – I make a lot more food at home now,” says Matthew. “I have also cancelled direct debits for subscriptions for things I don’t really use. Before I used the app, I didn’t really know where I was with bills and payments coming out of my account, and didn’t know how much I had left to spend. But now I have a much clearer picture of where I am.

“Having the app on my phone made it easy to see how much I had available to spend if, for example, someone suggested going for a drink. I’d probably still go, but I’d spend less money. I now have a surplus income each month, which I am using to pay off credit card debt and also to put into a savings account.”

Where to get help with budgeting

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I started budgetting some

I started budgetting some years. I use a technique adapted from a statement by C Northcote Parkinson that expenditure rises to meet income. In other words, the more you earn the more you spend. I put money into pots to meet future expenditure and this save for things that only come out once a year every month. Once in a pot, it is 'spent' so I can't spend it again. Worked well for me for the past 34 years. (Ouch, feeling old now!)