A budget is all about tracking and reporting all your sources and amounts of income, and all your uses of income. It should answer the questions "Where's all my money coming from, how much is there, and where's it all going?"
Before you get started, and to make the process more suspenseful and fun, jot down how much you think you're spending on food, entertainment, travel, clothing, charity, investing, etc. Then record how much you want to spend on them.
Next, gather information. For one to three months, record all your financial inflows and outflows. (One month will do, but a few more will maximize accuracy.) Try to account for big expenses that occur once or twice a year, such as car insurance, too. Jot down how much they amount to per month.
During this two- or three-month period, save every single receipt you get for any expense. If you don't normally ask for or keep receipts, do so during this period. Also, carry a small notebook to write down any cash transactions. If you spend a few dollars for coffee at a local coffee shop each morning, record each such transaction. If you do some odd jobs for a few extra dollars now and then, record that too.
After the information-collecting months are finished, sit down with all your records -- the big bunch of receipts, your checkbook, your pay stubs, credit card and bill statements, and that little notebook of cash transactions. You'll also want a pad of paper, a pen or pencil, and a calculator. Start making lists of all the inflows and outflows. Group them into categories and total the amounts for each item. For example, you might list all your eating-out expenses and all your supermarket expenses, and lump them together in a "Food" category. Then calculate what percentage of your income is spent on food. (Of course, if you fine-tune things more, separating supermarket and eating-out expenses, for example, that's even better.)
Make sure you're accounting for all your expenses. Even a $12 check written for a magazine subscription should be counted. As you're classifying expenses, notice that some of them are fixed, while others are more flexible.
Now, step back and see what you've got. You should be looking at a fascinating detailed record of where your money comes from and where it goes. Compare your actual expenses with your initial estimates and see how close you were. Assess whether you're saving and investing as much as you want to. See what changes you need to make in your habits to meet your goals.
Perhaps you can hit your savings goal simply by cutting out HBO and your subscription to Turtle Fancy magazine. Buy a water filter instead of endless jugs of bottled water. Use a fan sometimes instead of air conditioning. You might be able to save a tidy sum by giving slightly less extravagant gifts. Also, don't assume that fixed expenses are completely fixed. You might be able to refinance your mortgage to a lower rate. Or, a little comparison-shopping might turn up a less expensive insurance policy.
You might even discover that by spending less on some things you don't care so much about, you can spend more on things you care a lot about. For lots of ideas on how to save money, visit our Living Below Your Means discussion board. To learn from fellow budgeters, drop in on our Budgetingdiscussion board. Our budgeting calculators may also come in handy. Finally, check out The Motley Fool's Personal Finance Workbook, which is chock-full of handy worksheets including the Bit-by-Bit Budget.