A successful budget requires understanding two key things: INCOME and EXPENSES. It seems simple enough but sometimes it can be a bit more complicated and therefore frustrating. Let’s take a look at the different types of income and how they may influence your budget.
Related: Fixed vs Variable Expenses
But First… How To Budget
Here is a quick reminder on how to create a budget. For simplicity’s sake, I recommend creating and using a monthly budget. This allows you to stay in tune with your expenses as most bills occur on a monthly schedule. In addition, monthly budgets allow you to adjust month to month if something is not working properly.
So… Simply put a budget is:
YOUR INCOME – YOUR EXPENSES
As you build your budget you want to make sure your expenses are either equal to or less than your income. This will guarantee you are not spending over what you bring home.
Related: How to Make a Budget
The Importance of Your Income
Income is the backbone of your budget. Without income there simply isn’t a budget. So it is important to understand the different types of income and how they potentially affect your budget.
When we think of income we simply think of the money we make from our job. While that is true, it does go a little deeper than that. There are different types of income and depending on your specific type of income you may need to build your budget differently.
Salary vs Hourly Compensation
In the world of employment, employees are paid in one of two ways… Hourly or salary. Let’s dive into the differences in these income types and how they affect your budget.
Hourly Compensation
Hourly employees are paid for their work based on how many hours they work each week. Most commonly employees work a 40-hour week and therefore are paid an hourly wage multiplied by 40.
But in some cases, hourly employees may work over 40 hours per week and are then compensated with overtime. Overtime is any amount of work completed beyond 40 hours per week and often results in extra compensation. You may have heard of “time and a half” which literally means employees who work more than 40 hours will receive their hourly wage plus half their regular hourly wage for each hour they work over 40.
When creating your budget, if you or your spouse routinely work overtime as an hourly employee you will need to consider how you want to use these additional funds in your budget.
When building your budget it is important your recurrent expenses are budgeted for from your guaranteed income to ensure your expenses will be covered.
Because overtime is not usually a guaranteed income in most work, I would not recommend expecting this income each month. Instead, I would consider it “extra” and use the extra funds towards financial goals such as debt payoff or saving for specific goals such as an emergency fund or vacation.
It is also important to note that as an hourly employee, missed work without using PTO or other income-covering benefits, will result in earning less than 40 hours of income that week. This reduction in income will likely affect your budget negatively.
Salaried Compensation
Unlike hourly compensation, salary compensation does not include an hourly wage. Instead, employers agree to compensate an employee a specific amount of money for an entire year no matter the number of hours worked to complete the job.
Salaried employees usually have a greater degree of flexibility in their schedules in that they will be paid the same amount whether the work takes more or less than 40 hours per week. BUT that also means they are not eligible for overtime and therefore will not receive the benefit of overtime compensation.
Building a budget as a salaried employee is super easy! There is no need to worry about missed work or missed wages. Simply build your budget based on the agreed-upon salary income.
Because there is no option for additional income through overtime, all savings and debt payoff will have to be built into the main budget and come from the total salary amount.
When Do You Get Paid?
Once we understand the type of income we receive, it is important to know when we will receive that income. Paying bills and expenses depends on when we will have access to the funds.
There are several timelines for when employees receive their paychecks and each one will require us to manipulate the budget in a particular way.
Weekly & Bi-Weekly Paychecks
This is the most common way employers compensate their employees. At the end of either each week or every two weeks, employees receive a check for their work.
When building a budget we operate most often in a monthly context. This means the budget is built to reflect covering expenses and bills for one month at a time.
This means we will have to take our weekly or bi-weekly income and multiply it to determine our AVERAGE MONTHLY income. We will then use the monthly income value in our budget. Here is look at how to calculate your AVERAGE MONTHLY income
WEEKLY PAY:
Weekly Pay x 52(weeks in a year) = Yearly Total
Yearly Total/12 = AVERAGE MONTHLY INCOME
BIWEEKLY PAY:
BiWeekly Pay x 26(pay periods in a year) = Yearly Total
Yearly Total/12 = AVERAGE MONTHLY INCOME
Monthly or Seasonal Paychecks
Occasionally payment for work occurs monthly and in this instance, you will simply use that amount as your monthly income.
In other instances, your home might include seasonal employment. Seasonal employment involves income at only particular times of the year. This may or may not be recurring every year but it is important to take note of how this sort of income can affect your budget.
For the months you will have seasonal income, you have two options when building your budget.
1 You can average seasonal income into your monthly income throughout the year. If you know the amount of money you will be making each year you can average it into your monthly income. This would require you to put it away into savings in the higher-income months to cover the lower-income months.
or
You can simply have a surplus during your higher-income months. In these months, you could use this higher income to pay off debt or put towards sinking funds or other savings.
Related: What are sinking funds & why do you need them?
Regular vs Irregular Income
Different types of income also include regular vs irregular income. In some households all forms of income may be irregular, meaning there is a source of income that comes at varying times and perhaps inconsistently. This may be the case with small businesses that are based on sales or side work such as a handyman. Irregular income does not have to stop you from creating a budget for your family. It simply takes a few more steps.
If your family has a source of income that is irregular you will want to take some time (3-6 months) to see what your average monthly income is. Simply take those months to calculate how much you make and divide it out to find the average monthly income.
For example, if you own a small business based on sales and you sold $1500 worth of products in 3 months, that gives you an additional $500 per month in income on average. I would add this average to your monthly income. If you have months where you go above that in income, you can tuck it away to cover the lesser months or you can put it towards savings and debt payoff.
Gross vs Net Income
When it comes to understanding the different types of income, you might hear the terms Gross Income and Net Income. These terms refer to your earnings pre and post-benefits and taxes. It is important to understand these terms when you are creating your budget.
When working for an employer, the agreed-upon pay rate, whether hourly or salaried, is your gross income. This is the earnings before taxes and benefits have been taken out.
The money you will “take home” is your net income. This is the value after taxes and benefits have been removed. This is the value on which you will base your budget.
Creating Your Own Budget
Are you wanting to create a budget for your family? Not sure where to start? Sign up below for my FREE 5 day Well Planned Budget email course. I will send step-by-step instructions as well as printable tools directly to your inbox to help you create a budget that works for you.
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