How does a person construct a functional budget from scratch?

Many people only learn to budget out of necessity, after having raked up a significant amount of debt and deciding that this way of operating their finances is simply not sustainable. For many, this is an epiphany, but does not answer the question of HOW; as in "how do I make a budget"?

The following steps will aid you along your path to building a functional basic budget.

1. Calculate your actual net pay. There are two basic ways to do this:
  1. Take your gross pay, and use a "net paycheck" calculator to work out your net pay (that is your pay after you've paid your income taxes).
  2. Figure out how often you're paid and how much, and work out a monthly figure.
    (e.g. if you get paid $1200 biweekly, that's $1200 x 26 weeks / 12 months = $2600).
Now, you have how much you can spend.

2. Make a table with a list running down the left column side of expenses you might incur in any given month. The trick to this is not to make it too specific (e.g. "underwear", "accessories", "makeup", etc.) and not too broad (e.g. "stuff", "bills").

The following is a list of common budget categories, sorted into "fixed" and "variable" categories (you can eliminate the ones that don't apply to you).

Fixed Expenses
Note: these are the ones that you have to pay every month, the amount is more or less the same, and you have no room to play around with the amount.

Rent or Mortgage
Car Payment
Property Tax
Child Support or Other Family Support
Insurance (house)
Insurance (car)
Insurance (life)
Property, strata, or condo fees
Electricity and Water
Child care

Variable Expenses
Note: these are the expenses you can play around with to cut extra weight out of your expense budget, in order to put more money aside or pay down debt.

Food (groceries)
Furniture and Home Decor
Donations & Gifts
Transportation costs (public transportation, oil change, repairs, etc.)
Health and Dental costs
Prescription costs
Phone, cable, internet
Sports or memberships
Personal care
Bank Fees

Finally, Make a category for:
Note: these are the ones you want to maximize so you don't have the debt weighing on your shoulder, and so that you have enough saved to have peace of mind.
Debt Repayment
Emergency savings (for when your car breaks down, you get sick, etc.)
Retirement Savings
Savings for Children

Remember, that the quicker you pay off your debt, the less you pay in interest costs.

3. Go through your credit card statements and bank statements, to figure out how much you have actually been spending on these categories to date. Input these figures into the table you have just constructed (in pencil). The actual numbers may shock you.

4. Make another column next to your "actual spending column" to reflect your new designated amounts for each spending category. This is the part that will require thinking - honest, critical thinking. Depending on how much you've been spending, you may find you need to trim a little, or a lot, of your spending. Where can you pare back your spending? Maybe you're spending $80 every friday night with your friends at the local pub, costing you a whopping $320 per month to entertain yourself on friday nights alone. On the other hand, maybe your fixed costs are too high.

Here is a simple rule of thumb for figuring out where you're spending too much money:

Housing should cost - 35% of your net income
Life (entertainment, vacation, fun, buying stuff) should cost - 25% of your net income
Transportation should cost - 15% of your net income
Savings should take up - 10% of your net income
Debt Repayment should cost - 15% in order to be at a manageable level (of course, if you're carrying a crazy amount of debt, you may need to up this amount, and trim in the other areas).

While these are widely accepted numbers in the personal finance community, depending on special life circumstances, the percentage figures can be difficult to follow strictly.

For example, when I graduate from law school, I will likely be spending 50% or more of my net income on debt repayment, for at least the first year - because otherwise, it will take me a good portion of my life to pay the school debt off.

What problems do you have with these guidelines?
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