In the past I’ve tried to follow a budget, only to fail time and time again. But I’ve learned from my mistakes. Today I’m going to walk you through the steps you need to take to make a budget that really works.

Step 1: Record Your Income and Expenses for a Month

TIP: You can also use money management tool like Personal Capital to automatically track all of your income and expenses for you.

If you’re really organized, you can look back at your expenses for six months to a year, but I’m going to assume you’re organizationally challenged like I am. :) For one month, you need to record every transaction that you make with your money. Carry a notebook. Save receipts. Write down where every penny goes.

The notebook and receipts are important. You want to be specific. It doesn’t help you to write down “Spent $40 at Target.” Did you spend money on food? Towels? Electronics? You need to know these things.

If you’re adept at using spreadsheets, you can use a spreadsheet to categorize expenses. If you’re not, recording everything on a sheet of paper or in a Word document will be fine. The important thing is to record the information.

At the end of the month, if you’re like me, you will be surprised at how much money is leaking out of your bank account every month. The first month I recorded our expenses, we spent $300 on eating out. I’m not kidding. I was shocked.

We were also shocked at how much money we were using on little trips to the grocery store for snacks. We really had no idea.

At the end of the month, you will have a good idea of what your spending habits are. You’ll see the areas where you need to work on curtailing your spending, and you’ll notice areas where you could stand to put a little bit more money. You’re ready to move on to step 2.

Step 2: Write Down Income and Necessary Expenses

First write down how much net income you bring home every month. For now I’m going to assume you make a fixed amount every month. If you work on commission or some other irregular pay structure, here is an article on budgeting with an irregular income.

Next list the things you know you need to pay over the course of a year. Dave Ramsey has an excellent form to help you with this. Use the information you collected during your 30 days of recording expenses to help you with this. For variable bills, such as your electric and water bills, write down the average amount over the course of 12 months.

Don’t forget expenses that come up every six months or only once a year. Insurance premiums and car registration renewal are two that come to mind. Divide the total amount by the term covered, and enter that into your monthly expenses. If you pay your insurance every 6 months, divide the premium by 6, and that’s the amount you’re going to save toward insurance every month.

Finally, subtract all of your expenses from your income.

Step 3: Adjust

If your income is greater than your expenses, that’s fantastic! Take any extra income and put it toward your financial goals. This could be your emergency fund, debt repayment, retirement…the possibilities are endless!

If you’re like most people, though, your expenses will be greater than your income, and you will come to the sinking realization that you’ve been spending more than you earn. Don’t be discouraged. You can fix this.

You now need to cut areas of your budget that are flexible. If you’re spending $300 on eating out, that’s a good place to start. The grocery bill is also very flexible. But be realistic. Don’t budget $85 a month for food for a family of four. It will never work.

If you are having trouble making your income cover your expenses, and you can’t cut expenses any further, you need to think about raising your income. Can you take on a second job? Babysit? Blog?

Also consider contacting your credit card companies to see if you can arrange a lower payment. Or consider Consumer Credit Counseling. Just know that you cannot continue to spend more than you earn. If you do, things will only get worse. Take whatever steps are necessary to get your spending level below your level of income.

Step 4: Live by Your Plan, but Don’t Be Too Rigid

Once you have a budget in place, follow it. If you have already spent the $100 you budgeted for eating out for the month, don’t spend anymore. This is easier said than done, of course. I’ve screwed up many times. However, by keeping the budget in mind when you spend, you will continually move closer to your goals.

If you find you are consistently off in a budget category, perhaps you need to re-evaluate the budget. As gas prices went up, my husband and I had to adjust our auto fuel category up about $100 a month.

A budget isn’t set in stone. You can adjust it if it’s not working for you. The important thing is to start planning where your money goes. If you don’t have a plan for your money, it will just disappear on meaningless items. By making a plan, you can ensure that you are doing what you can to achieve your financial goals. Without a plan, your goals are just dreams.

Don’t miss the other two parts in the series!

Is there anything else you’d like to see covered while I’m on the subject of budgeting? Leave a comment and let me know!