One thing that is consistently despised is budgeting. It’s a rare thing for someone to really love budgeting, though it is almost a certainty that every person likes knowing what they are spending and having that spending under control.
The feeling of being out of control and lacking any clarity is deeply disempowering. The most typical response to that is to cease paying attention, make excuses and blame external events. Although the honest preference is for clarity and control, it can be very hard to break a negative cycle.
The good news is that it can also be very easy to improve the design of your financial system to help you with the discipline. Discipline with good design can make all sorts of things much easier. Applied to management of cashflow, we have found through our own experiences that this is absolutely true.
Like is so often the case, the tried and true is a great reference point for designing a system to solve a present day problem. So we looked for what has simply worked, without the need for complicated measurements and spreadsheets and budget planners. This took us back to the mid 1900’s (and earlier) when there wasn’t the surplus money to waste and credit facilities did not exist.
Back then, when the money came in, it was separated into spending categories to ensure that when the liability fell due, the money was there to make the required payment. Examples were the mortgage, groceries and bills, with some going for a rainy day. Many people can still remember a time when the biscuit tin or jars were literally used to separate the cash into their categories.
When applied with all the advantages of today’s technology, this system can be a highly effective means of controlling your budget, measuring what you are spending and ultimately, helping to make sure you are achieving what you really want financially (rather than wondering where it all goes!).
With our clients, we establish a number of bank accounts with whichever bank they are using on a day-to-day basis. We then establish a Cash Management Account and divert all sources of income to that account. This then acts as a collection account and regular amounts can be transferred into the day-to-day account to fund living and lifestyle expenses.
Importantly, the Cash Management Account must be with a different bank to the one being used on a daily basis. It must be out of sight and therefore, out of mind. Creating a barrier to access is vital to success because when there is a shortfall, the easiest thing is to simply go to the Cash Management Account and transfer more money, thereby undoing the benefits of a well-designed system.
Example
We have named one of the day-to-day accounts the “Bills” account. The purpose of this account is to pay for all the known and regular bills. We look back at what those bills have been over the past year or so and then set an amount to be transferred into the Bills account each month.
We then set up direct debits for each of the bills from the Bills account, knowing that in future, there will be sufficient to pay each of those bills as they come in. We would typically use the Bills account for items such as council rates, utilities, home and contents insurance, health insurance, car insurance, car registration, mobile phones etc.
Practical application
Importantly, now that we know what is being paid into an account, we are able to simply calculate the total cost of that category of expenses in your budget. The method can then be applied to other categories, such as “Everyday Spending” (i.e. groceries, alcohol, take away and eating out, leisure and fun, etc).
Separating categories is a very important aspect of the system, as it clearly highlights where the greatest tendency for variance exists. Most of the time, it is in the Everyday Spending account.
Although that transparency can be confronting, it is hugely empowering as it provides a clear opportunity to decide if you wish to consciously increase the budget in that category, or consciously reduce the amount being spent in that category. It focusses the attention and by doing so, makes the perceived problem much smaller and easier to manage. It also highlights the areas that are actually working well, which boosts confidence and encourages ongoing effort.
Summary
A well designed cash management system is the central component of a good financial plan. It is practically useful in helping reduce the amount of time being applied to menial tasks like paying bills, whilst ensuring you can have a good night sleep knowing things are being paid on time, every time.
It can also help remove the often significant emotion surrounding the “how much do I spend?” question and provide high quality information that allows for objective decision making, as well as more reliable cash flow modelling to inform future decisions.