There is an old saying that “Cash is King”. Its origins are unclear, but it has been widely used in reference to the tendency of companies and households to hold excess cash in times of uncertainty or distress to preserve flexibility.
In the financial planning world, I prefer to think of the phrase “Cash Flow is King” because understanding and managing one’s cash flow is critical to being able to build wealth and save for important life goals.
The first phase of managing your cash flow is to understand how much income you make each month, net of taxes. This should include your annual bonus or commission income, averaged out over the year. Once you know what your monthly net income is, you can decide how to allocate it.
The next step is to understand your spending. Instead of focusing exclusively on past spending, I help clients focus on where they’d like their future cash flow to go and develop a system to be more intentional about it. It involves getting a basic understanding of where your money has been going and categorizing it into three buckets:
Money Past – is money you have already spent or agreed to spend in the past (e.g., mortgage, utilities, preschool tuition, insurance). These expenses tend to be what people consider “fixed” expenses, although the exact dollar amounts might vary from month to month (e.g., a utility bill).
Money Present – is money you will spend in the next 7 days (e.g., eating out, transportation, entertainment). This tends to be highly discretionary spending and a good place to find necessary expense reductions.
Money Future – is money you will spend in the future (e.g., vacation, savings goals, car repair, home maintenance). It is a combination of both lumpy expenses and savings goals.
Once you’ve categorized your spending into the three buckets, you can analyze where you might be able to cut to make room for savings goals that are currently not being achieved. For example, you might find you are spending a lot on eating out or a gym membership you never use. Or you might be able to negotiate or lower some of your utility bills. It’s amazing what taking a close look at expenses can do.
Money Past – All your income goes into your Money Past account, which is typically your main checking account. All fixed expenses are paid from this account, as is your credit card bill, which is only used for Money Past or Future, but not for Money Present expenses.
Money Present – You have either one or two Money Present accounts that get funded each week with a set amount from the main checking account. Use cash or a debit card only for these expenses. When the account runs low, you will need to make changes to make the money last until the next weekly infusion (e.g., bring your lunch or make coffee at home).
Money Future – You may have as many of these savings accounts as you have categories of lumpy spending or savings goals. It can be as many as 10-12 accounts, so it’s best to open these with an online bank that pays high interest and where the process is easy. You then set up monthly deposits into these accounts in the targeted amounts. As you free up money by reducing spending elsewhere, you can increase the amount of the monthly deposits into your various savings goal accounts (e.g., college fund, emergency savings, new car down payment).
It takes a bit of work to get the system set up and to move money back from Money Future accounts each month, but I’ve found it helps clients gain a clearer understanding of their spending and be more intentional with it. This is particularly helpful for those struggling to make ends meet in what is a very expensive part of the country.