Step One: Calculate your net income

Gathering information about your monthly income is the first step to planning your budget. Budgets should be based around your net income, so only include the money you have after applicable taxes and deductions. Pull up your bank account and look at the money deposited for the last three months. Using an average over a couple of months will minimize the risk of inaccuracy caused by monthly income fluctuations.

Depending on how you earn money you may have to deduct taxes from the income you see in your bank account.

If you are an employee at a company your employer will most likely deduct taxes and mandatory contributions from your pay before it is deposited in your account, so you don’t need to make any modifications for tax purposes to calculate your net income. Simply add up the last 3 months of income and divide it by 3. This is your average monthly net income.

If you are self-employed or a gig-economy worker, you will have to factor in a monthly tax deduction on your income. If you have been working for more than a year you can use your tax payment from last year divided by 12 as a monthly baseline of tax deduction. For example, if you live in Ontario and make $52 000 a year you would have paid $14 043 in taxes and deductions last year. Using this information your monthly tax deduction would be $14 043 / 12 = $1 170.25. If you haven’t been working for a year, you should use an average of 3 months’ worth of income to calculate your annual income. This can also be done if your monthly income has recently changed. Tax calculators can be used to quickly find your yearly or monthly net income. The example below shows you what to do to get an accurate net income.

Net Income Calculation Example:

net income calculation for a gig worker making $40 000 a year in British Columbia

Step one: Calculate tax payable on gross earnings

Use this calculator to efficiently calculate total tax payable.

Total annual tax: $9 999

Step Two: Divide yearly tax payable by 12 to calculate monthly tax deduction.

Total monthly tax: $9 999 / 12 = $833.25

Step Three: Subtract monthly tax payable from gross monthly earnings

Monthly gross income: $40 000 / 12 = $3 333.33

Net income: $3 333.33 - $833.25 = $2 500.08

Once you’ve calculated your net income there is one remaining task before moving on.

You need to remove special payments such as judgments, child support, alimony, or other recurring payments that you are obligated to make. Do not include debt payments or mortgage payments. Subtract the total monthly payment of these items from your net income to finalize the income you can budget with. You can skip this step if none of the above apply to you.

Now you’re all set to start creating your budget!

Step Two: Create your budget

Sustainable budgets should be designed around net income, therefore all the prep work done in step one will be put to good use as we structure our monthly spending optimally. Depending on the budgeting strategy you choose there are exceptions to using your net income. A specific example is some budgeting strategies allocate housing can be equivalent to 30% of your gross income if you live in an expensive area. Most experts agree housing expenses inclusive of utilities (water, electricity, gas, heat) and rental insurance should never exceed 50% of your net income, so respect that threshold if you choose to use your gross income for calculating housing costs.

We recommend developing your budget exclusively with your net income. This provides the most accurate forecast and ensures you’re set up for success. Several budgeting strategies are popular and suit a variety of financial goals. The 50/30/20 strategy is recommended if you’re starting.

What is the 50/30/20 budget?

The 50/30/20 strategy gives a sustainable balance of allocating money towards supporting your current quality of living and planning for the future. The basic idea is to spend 50% of your net income on your needs, 30% on discretionary expenses, and save 20% for the future.

Shelter, food, water, insurance, and transportation are examples of needs. Don’t include anything extra in this category such as cable, Netflix, etc. Those fall into the discretionary category. Half your net income should be devoted to this category. If you’re finding it troublesome to not exceed this threshold, try creative solutions. If most of your transportation cost is commuting to work try finding a place closer to the office, or a job that allows you to work from home. If your rent or mortgage is pushing you outside this threshold consider moving to a less expensive house, or a more affordable area.

Discretionary expenses are things that you want but could do without in a pinch. Entertainment, internet service above basic high speed, eating at restaurants, food delivery services, and technology all fall into this category. These expenses should account for 30% or less of your monthly spending. If you’re consistently running over budget this is the category to start trimming expenses from first. Big-ticket items like cars, vacations, and boats are also part of this category. These less than essential items make your life better but aren’t a core part of your survival. Many people consider these expenses as “quality of life” enhancements. For instance, you may want to buy a Porsche, but a Toyota SUV will also get you from point A to B.

Saving is an essential part of a budget. Clear planning for the future is important. A good rule of thumb is to build 6 months’ worth of savings in cash before looking at alternate investment products. Some people choose to build up to 12 months of savings for added security, but once you have a comfortable threshold of savings consider longer-term higher-return investments like stocks, bonds, ETFs to grow your wealth. See the top three platforms in Canada. 20% of your monthly income should be allocated to savings or debt repayment. If you have any debt, it’s more efficient to pay it off than save money in a bank account. It’s important not to cut the allocation of this area. Saving money ultimately leads to financial freedom.

Now that you understand the basics of a 50/30/20 budget it’s time to create a plan based on your net income. Budget calculators can be used to automate the calculation of different areas. We’ve created a budget calculator which gives you a 50/30/20 budget in seconds. Alternatively, you can use the information above to build a 50/30/20 budget spreadsheet.

Once complete you’re ready for step three!

Step Three: Stick to the plan

We’ve come to the hardest step in this guide. Now that you’ve created your budget it’s time to stick to it. Over time you may find you need to adjust your spending depending on the time of the year.

December may have higher discretionary spending due to the holidays. Budgeting is fluid, but you need to ensure that if you exceed a category one month you trim it back in the next month to balance your yearly spending. If you are consistently exceeding your budget, you’re going to need to make tough choices and alter your lifestyle to get things back in line. Try trimming discretionary expenses by cooking at home, working out at home, cutting a streaming service, or scaling back your internet, cable, or cell phone plan.

Tracking your spending is extremely important to the success of your budget. Try to have a regular day in the middle of the month where you collect your transactions for the previous month and total up your needs, discretionary spending, and saving. Regularly doing this puts you in a budget-focused mindset and will help you make informed choices on whether you can get a Starbucks coffee each morning or buy a new tv. Collecting this data throughout the year gives you a good picture of how you spend and save your money.

Having a budget and regularly sticking to it is the first step towards informed financial choices and future success.