If you have ever unexpectedly bounced a check, had a debit card declined or looked in your wallet for a bill that seems to have mysteriously disappeared, you know how easy it is for money to flow into a household and right back out again before you have realized it.
Failure to identify the flow of income and expenses may also contribute to a household’s failure to write and stick to monthly budgets. Fortunately, pinning down your household’s cash flow does not require you to be a genius or enlisting the services of an expensive expert.
What is cash flow?
Cash flow is the path an individual’s money takes into the household and what happens to it once it is there. Generally, cash flow is calculated and analyzed on a monthly basis, but any period of time can be used. Quarterly or yearly assessments may be more appropriate or functional for some households.
Examining cash flow starts with looking at income. All of a household’s income should be accounted for, regardless of where it comes from or when during the target period it is received. Sources of income to consider include:
- Salaries, wages, tips and bonuses.
- Interest and dividends from bank accounts or investments.
- Payments made to the household from outside sources such as child or spousal support.
- Benefits or other supports from local, state or federal assistance programs, such as SNAP benefits.
Households assessing their cash flows should also take into account any infrequent or one-off sources of income such as annual tax returns or the money made on the sale of personal assets.
Once households have listed all of their sources of income and the corresponding amounts, it is time to do the same with expenses. As with income, the more thorough and accurate this list is, the clearer and more effective a picture of the household’s overall cash flow will emerge. Households should remember to include:
- Housing costs (rent or mortgage, insurance, utilities, fees).
- Food (groceries, restaurants).
- Transportation costs (vehicle loans and maintenance, fuel, public or rented transportation expenses, airfare, related insurance costs, registrations and other fees, etc.)
- Incidentals (household goods, clothing, personal care needs).
- Recreation (movies, outings, subscriptions to streaming services, etc.).
Individuals may wish to review recent banking and credit card statements to help them recall and include their common expenses and their actual costs for this exercise. Alternatively, they might elect to spend a month carefully recording all of their expenses before completing this part of the activity. Many free mobile apps have features that can assist with expenses tracking, as well.
How to Use a Cash Flow Assessment
Once an individual or household has recorded all of their costs and expenses in a basic spreadsheet, it is time to review the full cash flow picture. A cash flow assessment can tell a household:
- If there is a negative imbalance between income and expenses. Total income and total expenses are, perhaps, the most obvious place to start when reviewing a cash flow assessment. Households with net expenditures that exceed their net incomes have a dangerous imbalance of funds that sets them on the path toward long-term insolvency and debt. Fortunately, the cash flow assessment contains all of the information such households need to reevaluate their situations and pinpoint positive changes. This first step in reviewing a cash flow assessment frequently results in households realizing that they need to increase their incomes, they need to cut expenses or that they are spending significantly more or less than they thought on certain things.
- Where costs are higher than expected or believed. It is easy to lose track of how much money is spent each month on things like food, fuel or recreation. A cash flow worksheet highlights places where such expenses are unexpectedly piling up and provides insight into where changes in habits or increased attention might have the most positive impact on financial health.
- What the true cost of a particular expenses category is. Vehicles are a prime example of an expenses category in which small, frequent but decentralized expenses can quickly add up. Households may discover, for example, that the older car they have been driving actually commands so much money in fuel and maintenance costs that they would be better off leasing a newer, more fuel-efficient car for which maintenance is included in the contract.
- Where there are opportunities to reduce financial strain through advance planning. This is most likely to be evident to households that complete a quarterly or yearly cash flow assessment. They may find, for example, that insurance payments, holidays and other annual or semi-annual financial obligations cause the monthly cash expenditures in the months those extra payments are due to exceed income, causing significant financial strain. At the same time, the standard monthly cash flow assessment might show an opportunity to move a small amount of surplus income each month into a savings account without stressing finances at all. Using a cash flow to inform this type of advance planning can significantly reduce financial stress and improve long-term financial health.
- Where opportunities exist to reallocate money for a better return on investment. Cash flow assessments help households clearly see where their money is going and what they are getting out of it. Some households will inevitably find that money is inadvertently finding its way into expenditures that ultimately yield very little satisfaction or reward. These categories or expenses represent a prime opportunity to reallocate funds into investments or savings dedicated to larger, more rewarding goals.
Cash flow assessments also create a prime opportunity for individuals and households to verify that their earning and spending habits align with their larger life goals and priorities. For example, imagine that saving for a house is a family’s stated priority. If the family’s cash flow assessment shows that almost no money is being funneled into savings toward that goal each month, the household then has an opportunity to identify that their actions are misaligned with their goals. Because the cash flow lays out all of their income and expenses, the family can use it to easily determine where habits can be changed and funds rerouted to bring their cash flow into line with their goals.
By Melanie Henson –