Cash flow refers to how your money moves in your household, from the time it is received to when it is spent. “Positive” cash flow refers to having more money coming in than going out – in other words, spending less than you’re taking in every month. Positive cash flow is essential to financial solvency; if you take steps to increase your positive cash flow each month, you can then save and invest more each month for those goals that are most important to you.
Take a minute to really consider your short, medium, and long-term goals. What are they? For instance, do you want to:
- Purchase a new home, cabin, or vacation home?
- Make special home improvements?
- Start a business or change careers?
- Help your adult children and other loved ones who are experiencing financial troubles?
- Enjoy an early retirement?
- Go on a dream vacation or just travel regularly?
- Start a foundation and/or increase your charitable giving?
Finding Money to Fuel your Dreams
The only ways to increase your cash flow are to increase your income, cut your expenses, or some combination of the two.
Let’s start with increasing your income. Divorce can definitely impact a person’s financial situation, especially if it results in a need to change your working status in order to earn enough money to pay for both your short- and long-term needs. If your income is no longer sufficient to meet your goals, you need to revisit your situation. Perhaps you’ll need to find a job – or find a different job that provides you with a better salary. You might elect to pick up a temporary, part-time job in addition to your full-time job to create a cash cushion for yourself or to meet some immediate, pressing needs. You may decide to go back to school to learn new skills to make you either employable or more employable at a higher wage. Investing in yourself could be the best decision you make. By furthering your education and building additional skills, you become more marketable. Your increased income is yours for the rest of your working career.
Second, let’s look at cutting your spending as another way to improve your cash flow. To successfully identify ways in which you can cut your spending, you need to know exactly what you’re spending now and for what. That means your first step should be to develop a budget: a written plan that details both how you are currently spending and how you plan to spend your money in the future.
Creating a Budget
“Budget” is often considered a dirty word, but that may be part of the reason that households with credit card debt carry an average of $10,000 to $14,000, depending on the source you consult. Avoid being part of this statistic! If you’re one of those households who tend to carry a credit card balance, please read further to learn how to develop a budget and to live within it. If you’re the type of person who uses a credit card and pays it off every month, but still can’t save towards your really important goals, you also need to read further. You need to be able to develop and stick to a budget so that you can enjoy the life you have always wanted to – because you’re worth it!
Bottom line: Positive cash flow is the foundation of your financial plan. After a divorce, positive cash flow becomes even more important as dollars often need to stretch further to support two households instead of just one.
There are five key steps involved in making and sticking to a budget:
- Understand your income;
- Determine your historical spending;
- Project your future expenses;
- Organize your budget into a cash flow system that works for you;
- Monitor and update your cash flow system.
Step 1: Understand your Income
Income covers a lot of ground, but generally, it can include:
- Spousal maintenance/alimony
- Child support
- Part-time and full-time wages, bonuses and commissions paid to you by an employer
- Self-employed income
- Rental income
- Investment income such as interest and dividends
- Pensions and/or draws from retirement accounts.
Start by listing all your sources of income, as well as how often you receive each of them. For example, do you receive the income semi-monthly, bi-weekly, monthly, quarterly, semi-annually, or annually? Is the income fixed/guaranteed (such as a paycheck or spousal support) or variable (such as self-employed income)?
Because different sources of income are taxed differently, it’s also important to understand what your true after-tax income is. Seek out a financial professional skilled in tax matters who can assist you with this.
If you’ll be paying or receiving spousal or child support, you need to understand how the taxes will affect your income or your liabilities. For example, spousal support is usually taxable to the person receiving it and a tax-deduction for the person paying it. Child support, on the other hand, is neither taxable to the parent receiving it nor is it a tax-deduction for the one paying it.
Step 2: Determine your Historical Expenses
Your historical spending can be helpful data to have when developing a budget. Ideally, you should look back at 6–12 months of expenditures in order to accurately capture those expenses that do not come up monthly, such as car and home maintenance, vacations, kid’s sports and activities, insurance premiums, etc.
If you’ve been tracking your expenditures in a software program such as Quicken® or Excel®, or if you’re able to access summary spending information electronically from your bank or credit card company, you’re in luck: both of those sources give you a headstart in discovering how much you actually spend and for what.
If you don’t have access to that type of historical spending data, don’t worry. You can access a six-month sample budget that you can use to record your historical spending at ajwfinancial.com/new/amyjensonwolff1. Click on “Becoming a Client” → “Forms”, then choose to download either an excel or pdf version of the “Historical Spending Worksheet”. Just collect your bank statements, check- book register, credit card statement(s), a pen, a calculator, and a cup of coffee, and off you go!
Tips for Compiling Historical Expenses
For the sake of your sanity during this process, don’t try to document all of your spending to the penny! Instead, try to work on coming up with a monthly average for each of your categories. For example, if you spent roughly $150 in cash on holiday gifts in November, $350 cash in December, and then spent another $500 to pay off your gift-related credit card charges in January, your holiday gift total is $1,000 a year. That means you spent an average of $83 a month on holiday gifts.
Consult a friend or your financial advisor if you need some help in working through this process. And recognize and acknowledge that putting together your historical expenses is hard work, so be sure to reward yourself with a little something special when you finish this project!
Most people never make time to look at their spending habits; completing this exercise can be an eye-opening and educational experience.
Step 3: Project your Future Expenses
Next, project what your future monthly expenses will be. Since you now have an idea of how you spent money in the past, you have a framework for projecting your expenses moving forward. In fact, this exercise may actually trigger spending to go up in some areas while giving you motivation to reduce your expenses in other areas.
For instance, are you only spending $25 per month on entertainment? You only live once – maybe you should be having more fun! On the other hand, if you discover that you’re spending $500 per month dining out, carefully consider whether that amount is worth it to you, or whether you’d like to cut back on that expense to save towards another goal.
The key here is to be realistic based on your new financial situation. If your income has been cut significantly because of the divorce, but you’re still spending as you did before it, it’s time to recognize and change those old habits.
Tips for Projecting Realistic Expenses
Car purchase and maintenance. If you tend to keep your cars for eight years and think you’ll spend about $25,000 on a different vehicle, saving $260 per month ($25,000/96 months) means you’ll be able to buy a new car for cash when the time comes. If you tend to purchase cars more often, you may be able to factor in a trade-in or sale of your existing car when determining how much to save. The older the car you have, the more money you should be putting aside to take care of any unexpected repairs. Car maintenance includes oil changes, replacing tires, fixing brakes, and so on.
Home maintenance. If you are not sure how to budget for this item, here’s a good rule of thumb: set aside 1–2% of the value of your home on an annual basis for maintenance costs. That means that a home valued at $300,000 would probably have annual maintenance costs of between $3,000 and $6,000. Newer homes would probably fall at the lower end of this amount, as will homes where you plan to do a lot of the routine maintenance yourself. Costs will be on the higher end for an older home or for someone who needs to hire out help in this area. Home maintenance costs can include:
- Replacing your roof, siding, or windows;
- Caring for your lawn and garden (mowing, fertilizing, sprinkler system, annual flowers, landscaping);
- Fixing and replacing appliances;
- Repairing a plumbing or electrical problem;
- Cleaning and replacing carpets;
- Day-to-day things such as light bulbs, furnace filters, and so on.
- You may not need the full amount you budget for maintenance every year, but you might need much more than this in other years.
Holiday Expenses. December gift-giving and expenses are often missed when budgeting. Think through the gifts you give, the decorating you do, and the entertaining you host.
Vacation. This is another area that is often overlooked when budgeting. Consider land and air travel, car rental, hotels, and spending money. If you routinely take two trips a year to visit your parents or friends in another area of the country, put those expenses into your monthly budget.
“Big Box” Expenditures. Big Box stores are places such as Target, Wal-Mart, Costco, and Sam’s Club. If you visit your local big box an average of twice a month and never walk out of there without spending $200, put this into your budget as a separate line item.
How Much Should you be Spending?
Although every person’s situation will differ, financial coach and speaker Dave Ramsey (www.daveramsey.com) provides these common rules of thumb regarding what percentage of net income you should be spending:
- Housing: 25-35%
- Utilities: 5-10%
- Transportation: 10-15%
- Healthcare: 5-10%
- Food: 5-15%
- Investments/Savings: 5-10%
- Debt Payments: 5-10%
- Charitable Giving: 5-15%
- Entertainment/Recreation: 5-9%
- Misc. Personal: 2-7%
Step 4: Organize your Budget
There are many systems you can use to help yourself stay within your budget. Here is one system that has proven to work for those who want to keep it simple. Start by taking your projected expenses and breaking them out into three categories: fixed expenses, escrow or “saving” expenses, and living (discretionary) expenses.
Fixed expenses are those that do not change much from month to month. These include things like your mortgage payment, car payment, insurance premium and so on. Consider setting up a separate household checking account from which to pay these expenses.
Escrow expenses are those that are less frequent and which may be paid quarterly, annually or periodically throughout the year. These include things like car and home maintenance, real estate taxes, income taxes, holiday spending, some insurance premiums, etc. Consider setting up a separate checking account or savings account in which you put money each month to cover these costs as they come up.
Living expenses are everyday expenses, including groceries, dining out, gifts, haircuts, children’s allowance, entertainment, etc. Consider giving yourself a weekly or monthly allowance and pay cash for these items. Here’s why you should consider using cash for these expenses:
- If you have a budget of $800 per month for living expenses and you give yourself an allowance of $200 each week, looking in your wallet will make it crystal clear to you as to whether or not you can afford to eat out for lunch or whether you should be packing a lunch.
- When you’re strolling through a retail store, simply knowing that you are going to have to pay with cash when you check out will make you more mindful of what you put in your cart. And you really won’t miss those impulse purchases.
- You will never have a credit card bill you can’t afford to pay.
Switching to a new cash flow system is hard work – and it doesn’t happen overnight. Think of it as going on a diet or starting an exercise program: it will take a good 30 to 90 days to get into the swing of things and to make this a regular part of your lifestyle. And keep in mind that if you don’t consciously develop good money habits, you will subconsciously develop bad habits.
If you truly aren’t comfortable paying for your purchases with cash, consider setting up another bank account and transferring your allowance into that. Then use your debit card to access the dollars as needed. Just make sure you keep an eye on your balance so you know you’re staying on track.
If you’re one of those people who are really disciplined about staying within a budget, you can keep using your credit cards as long as you continue to pay off the balance every month. However, if you are ever unable to pay off the card, stop using it and reconsider the cash system.
Now that you know what your income is and what your budget is, think about how you can structure your income to “fund” each of the three areas mentioned above. For example, can you have your company payroll department send direct deposits in the appropriate amounts to each of your bank accounts? Does it work for you if you just deposit your child support check into the escrow account and your salary into the household account?
Your goal is to meet your budget – or better yet, to create even more positive cash flow. If your expenses exceed your income (which is very common the first time you try to stick to a new budget), go back and look for areas in which you can cut expenses. Alternatively, you could also explore options for increasing your income!
Step 5: Monitor and Update
Monitoring and updating your cash flow system as things change is the key to a successful long-term budget. If you’re working with a financial advisor, use that person to help you walk through this process. They can also help you stay accountable for your choices. If you aren’t working with a financial advisor, consider asking a friend to help you stay accountable to your plan!