We have many things to take care of and worry about in our day to day lives. What seems to be unlimited tasks in one day or week, makes it difficult to prioritize some important things. Not to mention, in a technology driven society, we rely on the cost of convenience. With our busy lives and the love of convenience, we inevitably neglect our day to day cash flow.
As an advisor, I have said time and time again, that managing your day to day cash flow correctly, is the secret to financial success. It is not a get rich quick scheme or an overnight success. It takes time, discipline, hard work, and sacrifice. This does not always go hand in hand with the love of convenience, unfortunately. Cash flow management is often my clients' biggest challenge. Today, I will give you a better understanding of cash flow management and practical tips to knock this puppy off of your day to day tasks like a pro.
Cash flow management is money that comes in and money that goes out. Think of your household and consider the money earned and the money spent. Simple right? Now, it is critical to make sure that the money coming in exceeds the amount going out. Poor cash flow management leads to high interest debt, no savings, and it makes building wealth nearly impossible.
For a healthy and balanced cash flow, I utilize the 50/30/20 rule for monthly expenses. Here are the categories:
- 50% represents critical expenses. This includes necessary expenses like the roof over your head, food on the table, transportation for work, insurance, medication, etc. If you find that your critical expenses surpass 50% of your income, then you need to make more income or find ways to reduce your fixed expenses. One example is to re-negotiate your car insurance payment or cell phone bill.
- 30% represents lifestyle expenses. This is your fun money which is typically used for eating out, clothing, beauty maintenance, weekend trips, etc. Lifestyle expenses are important to consider and I encourage my clients to enjoy their money because they work hard for it.
- 20% represents savings. This is money that is being set aside for your goals. Retirement savings should be prioritized over other goals like purchasing a home or other short-term goals in most cases.
The best thing that you can do is sit down, go through your bank statements for the previous 2-3 months, and make an itemized list in each category. Then, figure out how your money being allocated in each category. You will be surprised with what you find. Awareness is key to improve your cash flow and there is always room for improvement. Maybe you feel that you are not saving enough toward your goals or you feel guilty after buying yourself an expensive item. Doing this exercise will help clear uncertainty and doubts. You will also feel more in control of your money.
If you consider yourself a master budgeter, I still recommend that you still go through this exercise to see where you stand. If budgeting has not been your forte and you have incurred debt with high interest, consider using these parameters to recover your cash flow:
- 50% Critical Expense – try to minimize to lower than 50% if possible.
- 20% Lifestyle – minimize expenses as a short term sacrifice.
- 30% Debt – Use the snowball strategy. The snowball strategy consists of giving the minimum payment to each debt and using all additional dollars towards the smallest debt first. Once eliminated, proceed to the next debt. This category does not include your mortgage. Focus on high interest debts.
When I became a financial advisor, I learned how to manage my cash flow by trial and error. I adopted these methods and they have worked wonders for me as well as my clients. I cannot stress enough the importance of taking the time to sit down once a month to project expenses for the following month. This way you are telling your money where to go versus wondering where it went. I encourage young adults to practice these methods when they begin to earn an income. This is the formula for success when implemented early in life and it should not be kept a secret. Please share!