Your cash flow is how much you make (your income) minus how much you spend (your expenses). Despite this simple definition, producing a cash flow statement can seem like a tough task to complete. And, in doing so, you are likely to discover areas of spending where you need to change your habits, requiring a great deal of self-discipline and sacrifice. So, controlling your expenses as they relate to your income will not always be fun or easy. Why then, you may ask yourself, should you keep reading? Controlling your cash flow is the first and perhaps most important step to financial health. It is crucial in establishing a positive financial situation.
The entire financial planning process is dictated by your cash flow. Your cash flow will influence what your goals are, how much you can invest toward them, how long it will take to reach them, and how much insurance and estate planning you can afford. A positive cash flow allows you to direct cash toward paying down debt, building an emergency fund, and investing toward your financial goals. A negative cash flow, however, is a major “red flag” that indicates you must reduce or eliminate expenses before proceeding with investing and other activities.
As you now know, spending less than you make is vital to your financial health. To get started, lets divide how you control your cash flow into three easy steps: develop, budget, and act.
Develop
The best way to begin is to jump in and actually develop a statement of cash flow. Specifically, this is a list of all your income and expenses over a given time period, usually one year. Though it may take some effort, forming a proper statement of cash flow requires great detail—the more detail you put in, the more accurate and helpful it will be. You will need to know all of your income sources, as well as how much you spend on everything, from utilities to dining out to dry cleaning.
Getting started can be easier than you think. Begin with broad categories, then work your way down to details. First, list all of your income and expense categories. For example, you may have the following larger categories: “Income: Salary, Dividends, Rental Income. Expenses: Utilities, Mortgage, Education, Entertainment, Car.” Then, to each of the broad categories, add detail with more specific subcategories. For example, you may list these subcategories: “Income Subcategories: His Salary, Her Salary, Dividends from Stock Portfolio. Expense Subcategories: Water, Electric, Mortgage Interest, Mortgage Principal, Sports Tickets, Dining Out, Gasoline, Car Wash.” Once you have all of your subcategories listed, simply assign realistic estimates of how much you earn and spend over one calendar year. You now have a statement of cash flow (Cash Flow = Income - Expenses).
Budget
Now that all of your income and expenses are listed in your statement of cash flow, it is time to perform a thorough evaluation with the objective of spending less than you make. Since what we earn is usually out of our immediate control, you should concentrate on reducing or eliminating expenses. Unfortunately, many people only spend time and effort on trying to earn more instead of adjusting their expenses. This is wrong. If you have a negative cash flow, you must start with cutting and reducing your expenses—this is where you can quickly and more easily have a positive impact on your financial situation.
First, cut the obvious expenses, those that are not essential. Expenses such as Toys, Dining Out, Entertainment, Travel, Artwork, DVDs, and Clothes, can quickly be cut from your expenses without a major impact on the vital things. You will make the most difference by forcing yourself to give up those expenses that you do not really need. You must be completely honest with yourself when deciding what is essential and what you can live without. The success of your budget, and ultimate financial plan, depends heavily on your ability to recognize and admit what is not an essential expense. And remember, amounting credit card debt to pay for things is not a solution—this will only lead to even greater cash flow problems in the near future.
Once you have examined your optional expenses, take time to analyze and reduce your essential expenses. Look for better rates or ways to consolidate. As an example, by calling your phone company, you may find a plan that fits your needs for less than you currently pay. Or, by consolidating debt or refinancing you may be able to reduce your monthly payments or interest rates.
After getting to a point where you have excess income, you now have a budget! You can use this excess cash flow to start eliminating debt, establishing an emergency fund, and investing toward your future. Having a budget and a positive cash flow is very powerful and is the first step in improving your financial condition.
Act
After you have developed your budget, adhering to it is the real essence of controlling your cash flow. Sometimes this is easy, and sometimes it takes great motivation and determination. If your budget requires you to give up certain luxuries that you enjoy, you may have to find other less expensive ways of indulging yourself. There is no magic to this—no special planner, no creative way of arranging your statement of cash flow, no new technology that will do it for you. It takes simple grit and willpower. You must spend less than you make.
The general order of expenses should be:
1. Pay your necessary expenses,
2. Pay down debt,
3. Pay yourself (through establishing an emergency fund and investing), and only then
4. Indulge. Your budget is your framework to make this happen. Keep close track of all your expenses.
Utilize a budgeting software program, such as Microsoft Money or Quicken. Keep your receipts, diligently record every expense, and monitor your cash flow to make sure you are sticking to your budget.
You, and only you, can do it. It might not seem easy, and it might not seem fun. But, getting your financial situation under control is powerful and will be very positive for both your finances and you.
Conclusion
Remember, controlling your cash flow is a vital part of financial planning. The reality of achieving financial goals starts with a controlled cash flow. Analyzing your expenses and developing a budget is necessary in order to best control your cash flow. Spending less than you make may not seem exciting or enjoyable, but it is doable through a process of: developing a statement of cash flow, budgeting, and following through. Be sure to update your statement of cash flow and budget at least annually—your financial position will look better and better!
Written by CitrinGroup Staff 04/03/06
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