Editor's note: This article appeared originally in the May 2012 edition of the Debt-Proof Living Newsletter. 

I know what you’re thinking. Just the thought of the word ‘budget’ is like nails on a chalkboard. I know the feeling.

For many years I wouldn’t have anything to do with a budget because I couldn’t stand the idea of anyone—or anything—telling me how to spend my money. And where did that get me? Into one big financial mess.

Every month, when I ran out of money, I would turn to MasterCard and Visa for a bailout. Really bad idea.

What I learned from going through that experience and finding my way back to solvency is that, as much as we may loathe it, a budget is the ticket to financial happiness?not the straitjacket I feared it would be. I’ve come to prefer to call this a “spending plan” rather than a  budget, but honestly the terms are interchangable. It’s just a way to pre-spend your income so that every dollar is assigned a job to do.

Like the blueprints to build your dream house, a spending plan shows you where you are and how to get where you want to be. It’s the place where you spend your paycheck on paper even before you cash it.

A good spending plan gives every dollar a specific job to do. Once you have it just the way you want it, the plan becomes a handy road map for keeping your finances on track.

So, take a deep breath and let’s walk through the basics of creating a simple budget, or spending plan.

Step 1: Write down your total take-home monthly income

This is the easy part. Jot down what you earn. Because many expenses are billed monthly, it makes good sense to use monthly income to create your budget. Use the conversion table on page 4 to figure out your average monthly income.

Step 2: Write down your essential expenses

Start with fixed bills like rent, mortgage, car payment, credit-card debt and insurance, then factor in other monthly costs that are always the same. These are your essential fixed expenses.

Step 3: List your essential variable expenses

You know you’ll have these bills, but the amounts vary. Examples are your phone, utilities, food, household expenses, gasoline, medication, public transportation, shoes and clothing. You can assign an estimated amount to each based on past experience, rounding to the closest $10.

Step 4: List reasonable amounts for nonessential expenses

This includes entertainment, eating out, hobbies and other ways you spend money on a regular basis.

Step 5: Find the extras

Go to your current method of tracking your spending (your checkbook register, credit card statements, Quicken reports) to see what expenses you’ve left out. You’ll likely see items for car maintenance and repair, gifts, vacations, Christmas and holidays. For items that do not recur monthly, determine the annual cost, then divide by 12 to see how much you should set aside each month to anticipate that irregular expense.

Step 6: Figure out your totals

Add up your expenses, then subtract that amount from your income. With luck you’ll come out in the black, with at least a little money left over. But if your expenses exceed your income, you’ll see a negative sum. Don’t panic—this is just the start of an ongoing process.

Step 7: See where you can cut

If you came up short, go back to your projected monthly expenses and see what you can get rid of. Look first to your nonessential expenses. Which items can you remove altogether for a while (eating out seems like a fine target; perhaps hobby expenses, for a season)? Keep going through the list, making adjustments until your total expenses are less than your income.

Step 8: Follow your spending plan as closely as possible

Track your spending every day. Take notes and research ways you’ll be able to do even better next month. At month’s end, add up your actual spending and compare it with what you planned. Use this information to create the next month’s Spending Plan.

Congratulations—you’ve just elevated yourself from being clueless to financially savvy. You should feel very good about this!

As difficult as it might be to see in black and white that your income and expenses are not quite in sync, just knowing where you are is going to make all the difference.

Even if you find yourself in a particularly tight financial position right now, take heart. As you pay off debts and find more ways to cut expenses, you’ll begin to sense a significant loosening of financial pressure. Soon you’ll be ready to add new categories to your spending plan for things like saving for a new car, home improvements or going back to college.

The sooner you get started, the sooner you’ll be on your way to reaching financial freedom.

© 2012 Debt-Proof Living. All rights reserved. Used with permission.

"Debt-Proof Living" was founded in 1992 by Mary Hunt.  What began as a newsletter to encourage and empower people to break free from the bondage of consumer debt has grown into a huge community of ordinary people who have achieved remarkable success in their quest to effectively manage their money and stay out of debt.  Today, "The Cheapskate Monthly" is read by close to 100,000 Cheapskates.  Click here to subscribe.

Publication date: August 20, 2012