Today’s post is in response to a subscriber who asked about the need to have a budget. She asked if it was worth the time and effort to create one. I thought the best way to respond to her was to tell my story of how having a cash budget changed my money life.
Only 30% of people have a budget in place according to the financial media. At the same time, every week you see numerous articles expressing opinions about the need to have one. Some articles promote the importance of having a budget. Others spell out the negatives of budgets by saying they are a waste of time, not forward looking, and all they do is track spending and nothing more. I think the budget naysayers are missing the point.
I can tell you from my personal experience of having a cash budget in place for most of my adult life, that these people have it wrong. Having and using a monthly cash budget creates a positive money awareness or money mindset. My approach may not work for you, but reading this post may trigger ideas on how to set up your own cash budget.
I started having a cash budget when I was planning to attend college. I was paying my own way through school and trying to make ends meet, pay tuition, work part-time, and begin to build a future. The budget was my money lifeline as I needed all the cash I could get to afford school. My cash budget was a blessing because it showed me where I stood, where I was headed for the next 12 months, and what I needed to earn to make things balance out.
By the way, I set up my first cash budget using paper and a pencil, as at that time spreadsheets and budget apps did not exist. Over time, I migrated to a computer spreadsheet to accomplish what I needed. A properly set up and used cash budget reduces financial stress and money anxiety. My budget has always allowed me to find a way to save money regardless of what I was making at the time. Let me explain my process.
There are three objectives to an effective cash budget – planning, tracking, and taking action.
Planning
The first objective is to use the cash budget to plan. I have always set up my budget with a 12-month rolling time frame. What that means is if this is the month of October 2019 – my budget covers the period from October 1, 2019 to September 30, 2020. Here are the basic content elements that I track:
I start my cash budget by showing the cash I have in my bank account.
Next, I lay out all my major expense items and the months the bills are do. This includes my major categories of expense – housing, utilities, insurance covers, entertainment, savings, debt service, miscellaneous cash expenses and other items.
I use the spreadsheet to determine my cash flow each month – all cash earned from my after-tax earnings, unearned income from investments less my outlays after considering my starting balance.
The spreadsheet calculates for me the cash flow for each month – positive or negative. Some months I have a surplus or other months a deficit. A deficit happens when I have particularly large outlays such as prepaying for a vacation to save money or having to make an income tax payment. Overall, over 12 months I work to manage my net cash flow position to be positive, enabling me to save money by increasing my emergency fund or by investing.
Having a cash budget set-up like this is forward looking. It clearly shows me my monthly cash flow and how much cash I will generate over the next year. It shows me what I have available to add to my emergency fund, invest for later needs, to spend on vacations or if I need to cut back on my spending. Over the years, my forward looking cash budget has also signaled to me that I needed to earn more to have the lifestyle I wanted. It has also allowed me to always save money as that was one of my key goals.
Tracking
Each month I sit down and calculate the difference between what I projected as my month-end cash amount and what I actually had on hand. This makes me look at what I have spent on a category versus what I budgeted. For example, if I budgeted $200 for entertainment and spent $275 a need to be aware of why I spent more and decide if I need to change that spending pattern for the next month.
This type of analysis allows me to make changes in what I am showing in my plan for the next 12 months. It also signals if I need to watch my spending. Tracking is a key part to having a cash budget. If you don’t compare what you have spent to what you planned on spending you will miss the most valuable benefit of having a budget.
You can read in the financial press about the need to track small dollar spending amounts or to forego that cup of expensive coffee to add to your savings. The way I have looked at it over the years is that as long as I have positive cash flow for the next 12 months and I am saving money I could spend on those items that gave me enjoyment, saved time, or benefited others. What matters most is to be aware of your spending habits and to not spend more than you make. Simple but true.
Taking Action
There is no sense having a cash budget if you are not going use it to manage your money. You need to use the results of the process to understand your monthly cash flow, spending habits, progress on repaying any debt you have, clearly seeing how much you are earning after-taxes, and assessing how much you are saving. Your budget gives you the information to decide what actions you need to take to make your money life better.
Summary
I recently sat down with my nephew and taught him how to create and use this monthly cash budget process as he entered the last two years of his college education. We created his budget for those 24 months of college and when the process was over he could clearly relax about his financial situation as he could see what cash he was going to have to finish his education.
As I have written in the FinancialVerse, having a budget in place and using it is one of the ten things you must do. By putting in place a discipline to budget and reconcile your cash flow each month creates an awareness of your spending, earning and financial flexibility that you can’t get any other way. Based on my experience this process makes your money situation clear and understandable. The process reduces money anxiety and stress. It changed my life. It works.