Personal Budgeting Basics
Understanding Income
What's Your Starting Number?
Before you can plan where your money will go, you need a clear picture of how much is coming in. This is the first and most important step in building a budget. It sounds simple, but it's easy to get wrong if you're not sure which numbers to look at. The key is to understand the difference between what you earn and what you can actually spend.
The foundation of any good budget is an accurate understanding of your income.
Let's break down the two main types of income you'll see on a payslip or in your accounts.
Gross Income
noun
The total amount of money you earn before any deductions, such as taxes or health insurance premiums, are taken out.
Gross income is the big number at the top. It's exciting, but it's not the amount you have available for your daily expenses. That's where net income comes in.
Net Income
noun
The amount of money you actually receive after all deductions have been taken from your gross income. This is also known as 'take-home pay.'
Your net income is the realistic figure to use when creating your budget. It's the money that actually lands in your bank account, ready to be used.
All Your Income Sources
Many people have more than one stream of income. To get a complete picture, you need to account for everything. Your primary income source is usually the most consistent one, like a full-time or part-time job.
But don't forget about secondary sources, which can include:
- Freelance work or a side hustle
- Interest earned on savings accounts
- Income from a rental property
- Government benefits or allowances
Add up the net income from all these sources to find your total monthly income.
Never budget based on your gross income because that’s a sure way of coming up short every month.
Handling Irregular Income
What if your income changes from month to month? This is common for freelancers, gig workers, or people who work on commission. Budgeting with a variable income just requires a little extra planning.
The simplest method is to calculate your average monthly income. Look at what you've earned over the last three to six months, add it all up, and divide by the number of months. This gives you a conservative, realistic baseline to build your budget around.
| Month | Net Income |
|---|---|
| January | $2,200 |
| February | $1,800 |
| March | $2,500 |
| Total | $6,500 |
| Average | $2,167 |
In this example, you would use $2,167 as your monthly income for budgeting purposes. In months where you earn more, you'll have a surplus. In leaner months, you'll have a more accurate plan.
Now, let's test your knowledge on these concepts.
When creating a personal budget, which type of income should you use as the starting point for your calculations?
Your _____ income is the total amount you earn before taxes and other deductions, while your _____ income is the money you can actually spend.
Next up, a quick review of the key terms we've covered.
Getting a firm handle on your net income, from all sources, gives you the solid ground you need to build a budget that works.