A common approach to achieving the best use of cash involves picking the “low hanging fruit” by identifying and attacking your top five or so expenditures. This is usually done by looking at your spending patterns over time, and identifying recurring patterns and amounts that can be predicted and managed. Your adviser can provide you with help and tools to create a budget to do this.
The devil is in the detail
You may think you already know where most of your money is coming from and going and what the big chunks are. Salary and interest. Mortgage, school fees, car loan, investments, taxes. “OK, let’s move on”, you say. But before you do, consider that this knowledge isn’t enough to be meaningful. You need to know what elements are controllable and what aren’t, and what changes can be made to income and payments of these amounts to smooth out the peaks and troughs. It might also surprise you that one of your “big five” controllable expenses may actually be coming out of your ATM card, or from your teenage daughter’s mobile phone bill.
To develop a strategy to make the best use of your cash, you’ll need a budget. Creating and referring to a budget is the only way you will know what you are spending your cash on and what can be controlled. To create a meaningful budget, you’ll need to:
- Commit to the process;
- Establish a savings goal;
- Look at your income and spending history;
- Consider how that history helps or hinders the goals you’ve set earlier and develop strategies to correct bad habits;
- Consider new events that will affect your income and expenditure in the coming year;
- Set financial targets for key controllable elements based upon your strategies and new events; and
- Monitor your actual experience against your budget to identify and correct shortfalls to reach your goal.
Commit to the process
Creating a budget enables you to identify where all your money comes from and where it goes over a year, and is the only way for you to gain control over your cash. To create a budget, you’ll first need to realise the importance of doing so and commit to the process. There’s no point going through the exercise if your figures are based on wild guesses or wishful thinking. Remember the old axiom, “garbage in – garbage out”.
Establish a savings goal
The corporate business planning process can be a good model for setting personal goals. The comparison comes in handy concerning the budgeting process. When a company sets out to create its budget, the Chairman and Chief Executive will agree and set a profit target for the year, against which the budget will be built. In the same way, you should set your after tax savings goal for the year, for example at “10% of income”.
You might think that this target is easily achievable – but, do you really know that you are saving money at all? Later activities in the following chapter will help you to determine this. For the moment, and until you become more familiar with your budget, 10% of savings is probably a good rule of thumb.
Look at your income and spending history
Unfortunately, there’s no better way to identify your income and spending patterns than to simply keep a record of where all your cash comes from and goes over a period of at least three months. If you aren’t analysing your expenses over a full year, you’ll also need to consider other large one-off expenses that occur, such as rates or school fees. Once again, your adviser can provide you with a diary tool to collect information about your income and outgoings over your nominated period.
Next, consider what the resulting annual amount for each item is likely to be if you didn’t make any changes. This will be the basis for creating your budget.
Once you’ve identified all your income and expense categories and annual amounts, you’ll need to consider in which months these amounts occur. You’ll be doing this so that you can identify any peaks in expenditure and troughs in income that need to be managed. Again, your adviser can give you a worksheet for this purpose.
Put your history in context
If you’ve previously determined your goals in an earlier exercise, that is a logical place to start. Consider the financial impact of these goals over your budget period, and how your historical patterns impact negatively upon your goals. Work with your family to identify ways in which you can improve your historical income and spending patterns, and write the results in your budget worksheet.
Consider new events that impact your historical patterns
You may be expecting to change jobs in the coming year, or perhaps your daughter is moving out of the house. There may also be major capital expenses you are planning (such as a new car) that will impact your cash position. You’ll need to adjust your budget to account for things that will affect your historical patterns, and determine your expected cash flow for the year.
Set financial targets for the coming year
After all that hard work comes the fun part. You can play Treasurer and identify areas where spending cuts can be made, especially for major amounts that you can control. Do the same thing for income, assuming that you can make improvements there as well. At the end of this step, you’ll have completed your income and expense budget.
Monitor your activity
Anyone who has created a budget but has not compared actual activity against it over time has only done half the job. So far, you’ve identified and probably been surprised at your spending patterns, and have promised yourself to try to be good in the future. What you really need to do is to compare your actual activity against your budget on a regular basis and see what shortfalls arise, and then take steps to get yourself back on track.
As you’ve done during the budgeting process, you’ll also monitor your actuals to determine the best ways to smooth out the peaks and troughs in your monthly cash flow.
While your adviser can work with you to help you monitor progress and develop strategies in response, you might also consider:
- Disciplining your ATM withdrawals used for cash purchases to less than 5% of your total expenditures;
- Identifying and reducing your spending on luxuries (you’ll need to think twice about your definition here), especially if your history shows that you aren’t saving at least 10% of your after-tax income;
- Renegotiating contracts and getting a better deal for such things as mortgages, car loans, mobile phones;
- Working with your adviser to minimise your tax obligations; and
- Not increasing your spending in anticipation of windfalls or salary increases – they may not happen.
Finally, a by-product of this monitoring activity will be an increasingly accurate source of data against which you can prepare your next budget, so you can complete the cycle again.