Let’s face it, most of us never took a class on how to pay bills, budget, and manage debt. As a result, we often don’t have the knowledge we need to achieve financial stability. The key to getting your finances on solid ground is to understand how debt payments and other bills work, so you can develop the right strategy to manage each obligation that you have.
This guide will teach you how debts and other bill payments can differ. Then you can develop a budget that makes it easier to manage all your monthly payments.
Understanding the 3 types of expenses in your budget
Every budget has three basic types of expenses:
Fixed expenses are necessary expenses that have a set monthly cost. The amount you pay stays constant from one month to the next. Most fixed expenses are bills, including mortgage or rent payments, auto loan payments, insurance payments, and student loan payments.
Fixed expenses are generally the easiest to manage because you know exactly how much you need to pay. They take a set amount of money each month.
Flexible expenses are also necessary expenses, but they don’t have a set cost. The amount you’re required to pay can change from one month to the next. This includes bills, like utilities and mobile or internet services, as well as other necessary expenses, such as groceries.
Flexible expenses tend to be more challenging to manage in your budget because the cost isn’t set. You may need more money to cover a bill than you intended. However, some strategies can help you manage these expenses effectively, so you never come up short.
The last type of expense covers your wants. Discretionary expenses are all those nice-to-haves in your budget that aren’t necessities. Bills that are discretionary include subscriptions for streaming services, magazines, and newspapers. They also can include services, such as landscaping and housekeeping, which you don’t necessarily need to pay someone to do.
Discretionary expenses can easily overwhelm your budget if you don’t keep them in check. On the other hand, these are also the expenses that you can easily cut or cut back when you need to focus on paying off debt to regain stability.
Building a budget that helps you get on solid ground
Now that you understand the basic types of expenses that make up your budget, you can start to build one that manages your money effectively. As you work, remember that the goal of budgeting is to achieve and maintain financial stability. This means that your expenses need to be balanced against your income, so you don’t start to sink under the weight of everything you need to cover.
Follow these steps to make a budget that will help you stay afloat.
Step 1: Total up your income, based on what you really earn
The first step to setting a budget is to know how much income you have to work with. This means totaling up the monthly income that you receive. This can include:
- Part-time wages
- Pay for freelance or consulting work
- Income from a side gig
- Child support and alimony payments
- Government benefits
It’s important as you calculate your monthly income that you plan for the income you receive and not the income you should receive.
For example, if you are supposed to receive child support or alimony payments as part of your divorce, but your ex doesn’t always pay, don’t include this in your income calculation. This will help you avoid a situation where you allocate income to cover expenses and then don’t receive it.
Step 2: Factor in your fixed, flexible and discretionary expenses
Next, you want to detail all of your monthly expenses.
- Start by outlining all fixed expenses, since these tend to be the highest priorities in your budget.
- Then move on to outline flexible expenses. These tips can
help you determine the right amount to set for expenses that can change:
- For bills that vary in cost throughout the year, like utilities, review your statements to find the highest bill amount from last year. Then set this amount in your budget, so you know you can always afford the payments.
- For flexible expenses like groceries or gas for your car, take an average of what you spent on each expense over the past three months. Then set this as a spending target.
- Finally, add in your discretionary expenses. You factor these
in last because they are the first expenses to cut if you need to generate
- Make sure to include all of the incidental expenses you have each month, including your morning coffee, trips to the vending machine, and other small costs that may seem insubstantial.
- You may also want to consider dividing some expenses between what’s necessary and what’s a luxury. For example, food is a necessity, so groceries are a flexible expense because you need to eat. On the other hand, dining out may be a discretionary expense.
Step 3: Balance your expenses against your income
Now, you should total up your expenses and see how it compares to your income. At a minimum, you want to make sure that you spend less than you earn each month. Your income should always be higher than your expenses. It not, you need to make some cuts.
However, this strategy only ensures that you will barely scrape by each month. You’ll be living paycheck-paycheck, which isn’t where you want to be.
Your real goal should be to balance your expenses against your income so you only spend about 75% of what you earn. This will leave you with free cash flow, which is extra cash in your budget that you can use to cover unexpected expenses that inevitably come up each month.
Savings versus free cash flow
It’s important to note that free cash flow and savings are not the same things. If you leave savings to be “whatever money you have left at the end of the month,” you usually won’t end up saving anything at all.
Instead, saving money needs to be a planned fixed expense in your budget. Once you total up your income and expenses, see how much money you have available to save. Ideally, you want to save 5-10% of what you earn each month. But even if you can only save 1% or less, you should determine what the amount is and set it as a fixed expense.
That amount should be part of the 75% expense calculation. This will ensure you have money to save, as well as free cash flow to cover unexpected expenses. That way, the money you set aside won’t get drained every month covering unexpected costs.
Step 4: Find expenses that you can cut or cut back
Once you see your expenses detailed out, you can start to see where you may be wasting income each month. For example, you’ll see just how much you spend for that morning trip to the coffee shop or how much income you use to go out to lunch with your coworkers every day.
If you see you have an expense that’s draining your income (also known as a spending leak) you should close it. These tips can help you get started:
Evaluate your streaming services and subscriptions
If you have overlapping accounts, such as multiple paid music or movie streaming services, try canceling a few and limiting yourself to one subscription. The same is true with magazine and newspaper subscriptions.
Don’t pay for services you can do yourself
It may beeasier to pay someone to clean your house or mow your lawn. However, if you can save money by taking a few hours each week to do these chores yourself, it can be worth the cost-savings, especially while you’re working to eliminate debt.
Cut back on dining out, increase your grocery budget
As mentioned above, it can be useful to divide food expenses between groceries (a flexible expense) and dining out (a discretionary expense). This will allow you to scale back on food costs. You should be able to decrease your dining out budget significantly and only need to increase your grocery budget by a much smaller percentage to offset it.
Review bills to see if there are ways to reduce the cost
This is especially useful for flexible expense bills, such as your home phone and internet or mobile service. There may be features that you’re paying for in your plan that you don’t need or use. Cutting these features can help lower your bill payments.
Also, check your monthly mobile statements to see how much data you use. You could be paying for an unlimited plan when you don’t need it.
Finally, see if your electric bills have remained consistent across time. If you spent more this past summer to cool your home than you did the previous year, it could be a sign that you need a free home energy audit from your electric company.
Managing debt payments: Installment versus revolving
Just like necessary expenses can be fixed or flexible, so can your debt payments. Most debts are fixed expenses because they get paid in installments, including:
- Auto loans
- Student loans
- Personal loans
Loans are considered installment credit because you borrow a set amount of money that you pay back with fixed payments over a set time.
On the other hand, credit card bills are often a flexible expense because they are a type of revolving credit. With revolving credit, you have an open credit line that you can borrow against as needed. The monthly payment is typically set by taking a small percentage of the current balance, known as a minimum payment requirement.
These bills can be trickier to manage because the payments can change. The more you charge, the more you’ll be expected to pay.
But this can leave you between a rock and a hard place. If you charge too much, your payments increase. This will limit the free cash flow you have available to cover unexpected expenses. As a result, you may have an expense you can’t cover because your bills are too high. So, you use a credit card to cover it, which just increases your payment requirements even more.
This vicious cycle is why credit cards are the leading culprit of financial instability. If you’re carrying multiple credit card balances, you will likely need a specialized strategy to pay them off. This is often the key to stop drowning in bills.
With that in mind, we’ve created a separate guide to help you learn how to control credit card bills.
Stop drowning under credit card debt payments »