So last week we learned about how to calculate out networth, i.e. what we are worth when we subtract our assets from our liabilities.

This could be a negative of a positive, figure, a negative figure shows we owe more than we own, this is not always a bad thing. If we are younger and are borrowing to invest in assets like a home, that our current income can cover, this is ok. What we must avoid is negative networth as we reach the ending of our working life.

So this week we are going to talk about how to prepare a budget.

Lets assume you have a negative networth, caused by too much spending, thus you got a huge debt, and you want to reduce your spending, a great way to do this is to create and maintain a budget.

A budget allows you track your income and expenses, and ensure you have a disciplined approach to investing. So to do a budget I recommend a Microsoft Excel application.

You will maintain two Excel sheets, one will the “Projected “, the other will have same description but will be “Actual”.

For the first month, get a journal, and simply write out all projected expenses and incomes.we start our projected budget with income. We have two types of income,

Passive and Active income.

Passive Income is the income you earn by not personally being present or applying yourself, eg dividends, share of income for a business, rental income i.e. you don’t actively manage the business to earn an income.

Active income is income you earn from being at work mainly salary and commissions. Note you can be the owner of your own business and still earn a salary thus active income. Active refers to you “actively” managing or working at the company.

So take passive and active incomes from your journal and insert in your “projected” budget excel sheet, If you add both of them you get your Gross Income. Ok?

Next, break down list of expenses in your journal into projected Non-Discretionary and Discretionary expenses.

Non-discretionary expenses are the expenses you MUST make regards of your income, eg your investments, rent, food, bank loan repayments, etc… What can change here is the amount spent, not the item itself. Let’s call this

Discretionary expenses are expenses you can decide to forgo (especially if you lose your income) eg holiday in Dubai, some would even argue…Netflix.

Now after you do this subtract your Gross income from your Total Non-Discretionary Expenses This figure MUST BE positive ie you must earn enough to cover this. If you have a negative figure, stop here. You plan simply becomes increasing your income or reviewing your Non-Discretionary expense items.

After you subtract your Gross Income from your non-discretionary expenses what is left is your discretionary cashflow to be spent on Discretionary Expenses and perhaps reinvested. This is where you buy the new football jersey, or the new bag…..or increase your fixed income

End of the month, compare your actual to projected budget we prepared…if you’re spending more on a budget item than projected, you adjust down, spending less than projected? you ask do you need that expense?

The mismatch most common with preparing a budget is that we tend to go from income to expenses and then we invest the balance. This is wrong. The preferred model is when you get your income, you INVEST, then you pay down your NON Discretionary expenses, then the balance becomes your Discretionary expenses. If possible, reinvest all passive income into your savings.

The reality is if you cannot afford NOT to invest once you earn. Notice how I list investing as a non-discretionary expense.

Key difference in the preferred model is that you pay yourself first and allow your money to compound.

Now an important thing to add is the creation of an Emergency Fund. It’s important you have a minimum of 3 months (I recommend 6 months) Non-Discretionary expenses saved up in a very safe place, no risk. Probably just fix in a bank. This fund is what kick in in an emergency. This is the very first investment you should make. So once we determine the level of our non-discretionary expenses, we start saving towards that.

Op-Ed Editor