We all know the saying, “what you don’t know can’t hurt you.” When it comes to your personal finances, this couldn’t be farther from the truth.
Many times, there are problems simmering below the surface that we can’t see. They are like time bombs that will inevitably explode and sometimes, when its too late. More times than not, these problems get worse exponentially, making it ever so important to find them as early as possible. The most common problem — and sometimes the biggest — is fortunately the easiest one to identify and fix. This problem is a personal negative cash flow.
Businesses will use their cash flow statement for many things. Most importantly, they will use it to evaluate the overall health of its operations. Simply put, cash flow is a business’ comparison of cash in and cash out. Obviously, if a business has more cash going out than coming in, it will lead to big problems if it is not addressed. Your personal cash flow is no different. If you are spending more than you earn, of course, this is not ideal. One might ask, shouldn’t this problem be completely obvious? Well, not really. We live in a time when credit is so easily accessible. We often use many different debit cards and credit cards for spending. The use of so many accounts and credit cards can make identifying our spending habits extremely difficult and basically mask the problem.
If your goals include improving your personal finances, you just have to do one thing: this. Simply sit down with statements from all of your accounts and credit cards and categorize all of your expenses. You can use an excel spreadsheet, good old fashioned pen and paper or you can even find websites that offer a service to help categorize your past transactions. Use whatever method of categorizing that makes this process the most comfortable for you. When categorizing, I recommend using very specific categories (examples: food, gas, electricity, rent, etc.) and also putting them in a secondary category of “needs” and “wants”. The “needs” are exactly what you would expect. They are the things you absolutely can’t go without — food, rent and electricity. The “wants” would be everything else like eating at restaurants, memberships, trips to Starbucks, etc… Also take a tally of all the of the money you earned in the same time period. I recommend doing this for at least 6 months to give you a really good picture of your personal cash flow.
Now that you have these categories tallied up there are two things to note. First of course is the comparison between money in versus money out. Are you spending more than you are earning and if so are your credit card balances increasing accordingly? Second, take note of where you are spending, especially in the “want” category. Spending levels in certain categories may surprise you. You may realize you are spending way more in an area than you thought. A perfect example is eating out for lunch. Since an average day out for lunch may only be $10 here and $10 there it may not seem like a big deal, but once you add it all up you may be shocked at the total.
Ultimately this exercise will allow you to make the appropriate adjustments and help you make better spending decisions. Let’s use the “eating out for lunch” example from above. Let’s say you spent $1,000 over a 6 month period eating out for lunch. This would mean you spent about $2,000 in this category for the year. The point is not to eliminate this spending. We all love to head out of the office here and there to hit our favorite joints. The question is, could you cut back? Could you pack your lunch more often and pull this number back to $1,000 a year, and then put the extra $1,000 in savings?
You will be surprised at how much better this simple exercise will make you feel about your finances. It will give peace of mind, control and help you form a better relationship with your money. Good luck and let us know if you have any questions as you work through this exercise.
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