Q: We have been married for a few years, own a home (with a mortgage of course) and we think we want to have a child within the next year or two.

Currently we each make about the same amount of money, max out our 401(k) plans and spend all the rest. We eat out a lot and buy whatever we want, so we know we could live on much less.

We know the cost of a child will impact our lifestyles; how can we make sure we can afford a child? Do we have to start living on a budget?

A: Thanks for doing your part to keep the economy humming along!

A child will definitely impact your lifestyles in many ways, not just financially. If you've been spending as freely as your question implies, living on a budget for a year might be a good idea for a New Year's resolution.

Adhering to a budget is difficult, so if you find that you can't, an alternative is to set aside a certain amount of money and spend the rest. Determine the extra costs associated with a child and set that amount aside on a monthly basis.

Child care, food, clothing, medical coverage, furniture, equipment, education, entertainment and additional activities are some expenses for which to budget.

I've listed the following steps in response to an earlier question from a reader but they are applicable for anyone wanting to get a handle on their spending and net worth:

STEP 1: Set financial goals

List your financial goals and the expected costs of each. Break these out into three levels depending on the number of months or years by which you desire to reach the goal: 1) short-term (in the upcoming year), 2) mid-term (over the next five years), and 3) long-term (more than five years away).

Then prioritize the goals within each level.

Some examples of financial goals may be helpful:

* Short-term Goals

Cash management: Have three to six months of expenses in a liquid cash reserve account. Reduce credit card debt to nothing, pay off balance every month.

* Mid-term Goals

Vacation: Take the family to Disney World within two years.

Automobile: Purchase a new car within three years.

* Long-term Goals

Retirement: Determine expected income from pension plans, Social Security, investments, and other assets. Determine additional funds needed to retire at our desired age. Increase 401(k) contributions and start an outside investment program if necessary.

Education: Determine the amount needed to send children to a public/private university. Start a monthly investment program.

STEP 2: Analyze cash flow

Find out where all your money comes from and where it goes.

Gather your tax return, pay stub, checkbook, billing statements and any other records that have to do with money flowing in and out. Identify expenses that are fixed (have little or no flexibility such as your mortgage, insurance and taxes) and those that are discretionary (such as eating out, entertainment and impulse purchases).

Total income minus total expenses will let you know if you have a cash surplus or a cash deficit. Either way, this is something you need to know before you can develop a realistic financial plan.

STEP 3: Determine your net worth

This is simply a listing of what you own and what you owe.

For example: If you own a house with a market value of $150,000 and your mortgage balance is $100,000, you list the house and its value as an asset and the outstanding mortgage as a liability. If this were all you owned and owed, your net worth would be $50,000.

Obviously, the goal is to increase your net worth. Comparing your net worth statement year to year allows you to track your financial progress. Yearly updates allow you to make adjustments to your spending or saving habits in a timely manner.

Net worth and cash flow worksheets can be found on my web site.