How to Categorize Expenses and Budget Accurately
Knowing how to categorize expenses can help you build and stick to a budget.
Contributing Writer at Tally
January 10, 2022
There are dozens of online articles detailing small business expense categories. Common business expense categories include things like home office supplies, subscriptions, property taxes, health insurance and life insurance premiums, business loan payments and employee benefits.
These categories may be applicable if you’re self-employed, have a side hustle with a few employees or are tracking IRS tax deductions for a write-off. But they’re only really relevant for business purposes.
But what if you’re not a small business owner and simply trying to set up a budget for personal use? Unfortunately, there’s not much information out there when it comes to tracking expenses on a personal level.
Luckily, this guide on how to categorize expenses and budget accurately can help.
Learn which types of personal expenses to track when creating a budget, how much of your income you should expect to spend in each category and how this can potentially improve your financial situation.
Why an accurate budget is important
Knowing how to budget properly can set you on the path toward financial freedom. A budget lets you see your income relative to your expenses. More simply put, it allows you to plan and track your cash flows.
When you first set up a budget, you break down the money coming into your bank account each month and the money going out. By knowing these details, you have a better chance of paying for your expenses with cash vs. credit.
If there isn't money built into your budget for an expense, you’ll need to find another way to pay for it. Ideally, this would be via a rainy day or emergency fund. But, if you haven’t made that a savings goal, or you don’t have enough cash in the account, you may need to put the expense on a credit card or use a personal loan to cover the expense.
Using credit to pay for expenses has a knock-down effect and can cost you more in the long run, as you'll have to pay interest. But when you budget, you put yourself in a better position to be prepared for unexpected expenses. In fact, in a survey of 1,000 Americans, 80% indicated that they do indeed budget. Of those, 88% said that budgeting kept them out of debt.
Having a budget can also help you reach your financial goals. You can build your goals into your budget to help hold you accountable and increase your chances of achieving them. Perhaps you decide to invest in a retirement account, like a 403(b) or a 401(k). Or maybe you budget to set aside $10 per week into a savings account. That $10 may not seem like much now, but it will add up to more than $500 by the end of the year.
In summary, a budget is important because:
It can help hold you accountable and focused on your financial goals
It can prevent you from spending money you don't have
If you have a spending problem, it will quickly be exposed by your budget plan
The expense categories you should include in your budget
Everyone's personal financial situation is different. Some people may rent an apartment, while others buy a house and pay a mortgage. Some people may have children, while others have pets.
It's important to remember this when creating a budget. Your budget needs to be something that works for you and fits your lifestyle. Having said that, knowing how to categorize expenses properly can go a long way toward ensuring your budget sticks.
From a high-level view, you can categorize your expenses in three different ways:
Necessities: 50% of your expenses
Wants: 30% of your expenses
Savings/Debt payoff: 20% of your expenses
Let's take a closer look at what each of these three categories entails.
You should aim to spend 50% of your after-tax income on necessities. Your after-tax income is the money you receive in your bank account each week after your employer’s withholdings from your gross taxable income. For instance, if you earn $1,000 per week, you may receive around $700 in your bank account. This would mean roughly $350 of your weekly pay should go toward necessities.
An obvious expense within this category is housing. Your rent or mortgage is likely a fixed payment, which makes it easier to budget for since you have a better idea of what to expect.
Other types of necessities you may need to work into your budget include:
Travel expenses/vehicle expenses
Cell phone bills
Minimum debt repayments
Necessities are things you can't afford to not purchase.
Wants are otherwise known as discretionary spending. You should aim to spend no more than 30% of your after-tax income on wants. Spending less is certainly OK, especially if you need to allocate more toward one of the other expense categories.
Examples of wants that you may choose to factor into your budget include:
Purchasing new clothes
Going out with friends
Airfare for vacations
Entertainment expenses, like tickets to a show or sporting event
This type of expense is one that you enjoy but could ultimately live without.
Ideally, you would put 20% of your expenses into savings or debt payoff. As mentioned previously, it’s wise to keep making minimum payments on all your outstanding debts. Those minimum payments should be included in your necessary expenses, as missing them could have severe consequences both on your credit score and the amount of money you owe your lender.
You can use this 20% category to pay down debt beyond the minimum amount due using the debt avalanche or debt snowball method. Depending on which method you pick, you can strategically focus on paying off debt, ultimately reducing how much you owe in interest and paving the path to financial freedom.
If you do have credit card debt, you could use a tool like Tally† to help pay off your debts quickly and efficiently.
Once you’re out of debt, you can put the money from this category into savings. Options include emergency funds, savings for a life event like a down payment on a home or retirement.
Knowing how to categorize expenses can help you reach your financial goals
A budget can be a useful tool to keep your personal finances on track by getting out of debt and starting to save money. How you set up a budget can go a long way in determining whether it will stick. Learning how to categorize expenses can help and sorting your expenses into needs, wants, and savings/debt is a great place to start.
If you're looking to make the most out of the "savings/debt" category, consider Tally†. Tally is a credit card payoff app designed to help you get out of credit card debt and put you on the path toward financial freedom.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.