Cash flow management is about managing the income flowing into the household against the money flowing out of the household, and you can’t do that unless you have an effective method of measuring both areas.
Now that we’ve finished talking about protecting your assets by securing adequate insurance coverage, it’s time to focus on properly managing your cash flow. Simply stated, cash flow management is about managing the income flowing into the household against the money flowing out of the household, and you can’t do that unless you have an effective method of measuring both areas.
It may sound like an easy thing to do, but when you hear story after story about people who earn six figures yet have no savings, that’s a failure of cash flow management. When you hear about people living above their means, that’s poor cash flow management. When people decide to spend $4 every morning for that skim mocha latte, they are making a cash flow decision that could impact their standard of living, now and in the future. So it’s important to get a sense of what your expenses are and how much you can afford.
Cash inflow can include paychecks, interest income, dividends on investments, social security payments, retirement income, pension plan payouts, annuities, disability payments, and legal settlements. Cash outflow should be bucketed in three areas: expenses, taxes (property, income, asset and sales), and savings, with the only caveat being that you may not need to save if you are already comfortably in retirement.
Any income that is not reserved for savings should be grouped into two expense types: tax-preferenced and non-tax-preferenced. Examples of tax-preferenced expenses include medical expenses and property taxes; non-tax-preferenced expenses would be utility bills, grocery bills, or entertainment. It is important to separate these expenses and keep careful track of them as they can impact your tax liability.
But perhaps the most important step is taking the first step, and that is making a plan. Regardless of your income, it will be difficult, if not impossible, to make progress toward a goal if you don’t understand where your money is going on a monthly or weekly basis. And, don’t just keep track of the bills. Don’t forget “walking around” money: coffee every morning; ice cream for the kids; lunch at work. These are typically cash expenses, and you may be surprised at what these small-ticket items can add up to every month.
Just as often, people fail to plan for the big projects in life: vacation expenses; home improvement; or a new car. Make these expenses an integral part of your plan or you will eventually either need to borrow money or dip into your savings to pay for them.
Here are some other tips for an effective cash flow management plan:
1. Don’t lump your credit card expenses together. Credit cards are a means of paying, not an expense.
2. Don’t make things too difficult by trying to detail every expense. Electric, gas, and dry cleaning, for example, can all be classified together.
3. Try to “smooth out” expenses that are seasonal or semi-annual, such as pool memberships, quarterly tax payments or insurance premiums. You can even do this for infrequent or one-time expenses such as new car purchases or wedding expenses. Try to anticipate these expenses the same way you would approach savings for your children’s college education. Put aside a small portion every year.
4. Pay yourself first. You’ve likely heard it before and it’s never been more important. You should have an automatic savings mechanism in place to ensure your cash flow can continue well into retirement to help pay future expenses.
If you don’t have a cash flow plan, consider developing one for yourself. It is not a question of how much or how little you earn; it’s about managing your expenses, and avoiding unnecessary ones so that you can properly and efficiently save toward your goals. If your goal is financial independence, good cash flow management is one of the best ways to get there.