Improving Cash Flow: Stay On Top Of Debts To Yourself
by Mr Frugal • August 19, 2011 • Money Management and Planning • 16 Comments
Savings is better than debt. But cash flow trumps them both. It’s not talked about that often. Discussions often go to budgeting. But budgeting doesn’t automatically fix cash flow issues.
If you don’t know what it is, cash flow is the money coming in and going out. It’s your paycheck and your spending. When you’re broke, cash flow is what makes things difficult.
Worst-case scenario, you don’t have a budget. If this is you, take some time to write one up, then come back and keep reading.
A better scenario is that you have a budget. But maybe you’ve found that having a budget still hasn’t gotten you where you thought it would in terms of getting on top of your finances. If your income is only slightly above your expenses, this could very easily be you.
My story
I used to be anxious all the time about money. Money went out as soon as it came in. I had a budget, but it didn’t seem to help all that much. Unexpected things happened, more money went out than I had planned on, and things were always tight.
I used to reason my way through these moments by chalking it up to “the unexpected”. But this didn’t help the situation, and it didn’t prepare me for the next time it happened. I really just didn’t have a good solution for the cash flow issue.
My wife and I pared down our expenses. We cancelled our cable, we downgraded various services here and there. But this didn’t really help much. It was good that we cut back. But it didn’t solve the cash flow problem.
We eventually hit bone. There just wasn’t anything left to cut. We bounced around for a few months until we developed a system that actually worked.
Envelopes
At a certain point we had enough wiggle room in the budget to be able to put some money into savings. This felt like a major step forward, and it was. But we found that we still needed more structure. We found ourselves dipping into savings to cover unexpected expenses. This was disheartening because it meant that we weren’t really saving. The money that was supposed to be our emergency fund had turned into just an overdraft fund.
So, we tried the envelope system. The basic idea is that you break expenses into categories. There’s an envelope for each category. When money comes in, it’s split into the envelopes and when the envelope is empty, you don’t get to spend any more in that category until more money comes in.
The problem with envelopes is that it’s still susceptible to unexpected events. It seemed that the better we were doing, measured by the amount of cash in our savings account, the more expensive the unexpected event.
The missing piece
We were able to put together enough cash between our paychecks to pay the bills each month. But we were essentially borrowing from one paycheck to cover shortfalls in the previous one (or in some cases, several). This didn’t become a problem after just one or two paychecks. But as the months went on, we got further and further behind. Eventually our finances became a real struggle.
To get back on track we started keeping track of the unexpected events in a journal. Each time we had to take money from one envelope to cover a shortfall in another we wrote down how much we took, from which envelope, what it was for and whether or not it had to be paid back.
What this showed us was a form of debt that we hadn’t been managing. You might have heard about the importance of paying yourself first. Well, this takes that to a whole new level.
When you borrow money from a bank, they expect you to pay it back. When you borrow money from yourself, do you expect the same?
I never did. And this was my problem. By not keeping track of spending that didn’t fit into the budget I was essentially stealing from myself and turning a blind eye. And this was the missing piece.
Fighting back
Now that I could see where the money was leaking from the budget, I could fix it. So here’s how we prioritize our spending:
- Savings: Top priority until the emergency fund is built up.
- Bills: We try to minimize them. But being late on bills makes you feel broke. So get in the rhythm of paying your bills on-time, if not early.
- Debts to savings: Pay back the debts to our budget accounts and then cross them off in our journal. This allows you to keep your head above water in all expense categories. Keeping all of your envelope balances where they should be.
- Debts to creditors: Creditors are happy for you to have lots of debt to them. The more debt you have, the more money they make. These debts are the most expensive, but they’re not the most urgent. Pay them back as fast as you can, but try to minimize their impact on cash flow.
What about personal finance software
You might be thinking that your personal finance software does all this for you. It shows you your categorized spending. It know how much you’ve budgeted for each of those categories. But there’s one thing it doesn’t show you. It doesn’t show you where you take money from when you overspend. In other words, when you overspend on groceries one month, from where did you take the money to cover that extra expense. And this is the key insight.
The reward
With this approach we feel in-control a lot more than we used to. Unexpected events happen. But they’re not as scary as they used to be. We can see the cumulative effect of things like the car breaking down or an unplanned medical expense. And we can build room for them into our budget now.
We’re much better at budgeting now. We can see which categories incur overages more than others. We can adjust our budget to account for this long term effect. We have more cash on hand. We’re more effective at building savings. We worry less about unexpected events, because we know how to pay for them. And we have a much better perspective on debt.
So what’s your story? Have you had cash flow troubles of your own? Have unexpected events taken a toll on your savings? How did you respond and what were the results?
Wow! It is cool to read an article on something we do! I keep ledgers for our budget and I just go into the negatives if we have to go over budget in an area. We always have to pay ourselves back if we want to get back into the black. I have felt a little guilty about this because it feels like cheating even though it really works for us. For example, my husband has spent the last year getting all of his licenses to be able to hunt. Hunting is an expensive sport to get into and it is very limited as to when you are able to do it. He wanted to hunt deer in the fall and all the little things needed to do this really added up. He went into the negatives on his spending account and he was able to enjoy the hunting season. Since then, he has not been spending money since he has to get his account back into shape. Further, he has been finding ways to make extra money in order to expediate this. This is the first budget that has really worked for us and I think it is because we allow ourselves this flexibility to borrow from and pay ourselves back. I do adjust amounts if I find that we are constantly in the red in a certain category but usually we are only in the red because of a one time larger expense for a good reason. I should mention, when I say we are in the negatives we are not paying interest or anything. We are just borrowing from our savings (they are all stashed together in the bank).
Thanks for taking the time to share your story Marianne. I’m really happy that you’ve found a system that works for you.
You mentioned a few key points that I’d like to highlight:
1) When you borrow money from the “family bank”, you don’t pay interest. Interest is what makes it so incredibly hard to pay your way out of credit card debt. Those monthly minimum payments just get eaten up by interest. When you borrow from yourself though, it’s infinitely more manageable.
2) You’re finding ways to do the things you really want to do responsibly. Your husband chose something that really matters to him and committed to making that a priority. As I’ve said several times on the blog, you can have the things that matter most to you. But you can’t have everything you want and still keep your finances in balance.
I’m really excited for you and your family. You’ve found a system that allows you to keep your budget in balance and STILL do the things you care most about. Good for you!
I wish you all the best!
Great article you’ve written here. I think your story is inspirational and will ring true with many people when they read it. It is very easy to steal from yourself without even knowing that you are doing it.
I move money around our accounts all the time to cover expenses until the money comes in to properly pay them off. It always makes me uncomfortable too when I have to do that!
Hi SavingMentor. Thanks for the comment.
I’m glad you got something helpful from the article. Money’s greatest asset is it’s fungibility. $1 is $1. There’s no difference between the dollar you needed to spend and the dollar you really should have saved, unless you make the difference yourself. But starting with a budget and spending plan I give myself room to take care of everything I need to take care of. By splitting out my income into separate accounts I provide separation between the money I need to spend for basic expenses and the money that I choose to spend on things I want but don’t really need. This keeps my cash flow intact.
There are always times when a little extra is needed here or there for something important, or just because you want to have a little fun. And that OK! But spent money never returns (spending is not the same thing as investing). So keeping track of those extra expenses is essential in order to prevent spending from overwhelming or eating into my basic cash flow. If the extra spending starts to go too far, then the brakes come on and I just have to say no to extra expenses for a while until I build back up my reserves. The system works really well for me.
In order for my system to work over the long term it’s essential to pay myself first. Money for long term savings gets put aside from every pile of money that comes in. This way, all my bases are covered.
I’ve lost way, way to many opportunities in my lifetime due to bad financial management. I know that uncomfortable feeling you mentioned all too well. And I’m fiercely committed to having it happen seldom, if at all for the rest of my life. The feeling of being in control and kept up on all of my financial interests is one of the best feelings ever. It’s tremendously satisfying and comforting. I’m not sure I would have appreciated how important it is without having gone through the experiences that I did. But the lessons have been learned, and I’m never going back.
I wish you the best.
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We were months behind on everything but out rent, probably because our rent was way more than we could afford. I was always stressed and felt helpless. We took a lot of baby steps to build momentum and today, things are better, not great, but better nonetheless.
Hi Jen,
I’m glad to hear that you’re making progress.
What changes did you make? What worked for you?
The #1 thing was realizing that my husband was working his a$$ off everyday and was never going to have anything aside from debt to show for it. That one really broke my heart.
Next, I started saving $0.99 a week until we could handle that, then kept adding to it. Then expanding savings in other areas and working on debt and such.
That’s the comment-sized version.
Good for you!
I’m cracking up at the $0.99. Seems like it would be easier to just save a single dollar than $0.99.
The point is that you took a step in the right direction. You started small to get in the habit and then built your way up from there.
Did you downsize your rent too?
Sometimes you can improve your situation with changes to relatively small expenses like ordering regular coffee instead of the latte, fewer trips to the movies, etc. But sometimes you really have to make big shifts, like reducing your rent. It’s a major disruption to move, but the savings in the long run can be significant.
What did you do?
Excellent topic, and great personal finance spin to it! Don’t forget that overall cash management ties right into cash flow itself. How much money that goes in and out is a crucial thing to be aware of, but what you do with the money that “stays in” is quite important as well.
Thanks Justin. Cash flow is such an important topic for anyone living paycheck to paycheck. And the statistics on how many people are living paycheck to paycheck are staggering.
How do you manage cash flow? How do you prioritize your spending?
It’s so true that cash flow is important to maintaining a budget and if you don’t save or if you spend the money you have saved, then you are stealing from yourself. I don’t have a problem saving but it takes a while to build up an emergency fund if emergencies keep happening so I understand your dilemma. the best you can do is just to keep saving and paying yourself as much as you can. And also find ways to make extra money to cover the shortfalls.
FSYA, I’m glad to hear that the subject of cash flow resonates with you.
What’s your experience with recent college graduates? How do they seem to handle all of a sudden having (relatively) lots of money coming in? Got any interesting stories to share?