Due to the impact of coronavirus, many people are having to navigate unexpected changes in income and expenses for the first time in their life. This is something I have been talking about over the past few weeks with clients, during presentations and podcast interviews.
Cash flow management is the cornerstone of successful wealth accumulation. It doesn’t matter how much you earn, if you don’t manage cash flow effectively, it’s unlikely that you will be successful with building wealth. I have seen clients with 7-figure incomes that have little wealth to show for it. Conversely, other people with relatively modest incomes but very good cash flow management practices, have successfully accumulated a lot of wealth.
Managing cash flow does not have to be painful
The topic of cash flow management feels painful to many people. It tends to create connotations of curtailing expenditure on all the fun things in life. However, in the main, that is not the case.
The main aim of best-practice cash flow management is to eliminate unconscious expenditure.
Conscious versus unconscious expenditure
Most people do not consciously make bad financial decisions. Therefore, the insidious consequence of not tracking cash flow means that money ‘disappears’ on items that add very little enjoyment to your life. As such, eliminating this unconscious expenditure not only saves you money, but is likely to have very little impact on your standard of living.
You cannot manage what you do not measure
The best way to eliminate unconscious expenditure is to measure how much you spend in total on all discretionary items. You do not need to track every single expense, just a monthly or fortnightly total.
I typically like to allocate expenses into seven categories.
Non-discretionary expenses
1. financial commitments, such as rent, mortgages, car leases and child support.
2. utilities, including costs for gas, electricity, rates, phone, water, internet and contents insurance.
3. health and education, such as school fees, health insurance, medical expenses and child care.
Discretionary expenses
4. shopping and transport, like food, clothing, beauty, petrol, car maintenance and public transport expenses.
5. entertainment, including spending on annual holidays, gifts, eating out, movies and coffees.
6. cash, which is all withdrawals from ATMs – if this figure is high, stop using cash and start using EFTPOS or credit cards more often, as this makes tracking your spending much easier. Remember, you can’t manage what you can’t measure.
7. other, which is anything that doesn’t fit in the preceding categories.
Use two separate bank accounts
Your salary income should be directed into one account, typically the (offset) account that is linked to your home loan. We will call this a ‘savings’ account. Pay all non-discretionary expenses from this account (categories 1 to 3 above).
Then transfer a set amount each week, fortnight or month into the ‘spending’ account and pay all expenses in categories 4 to 7 (above) from the ‘spending’ account. This is depicted in the diagram below (taken from my new book, Rule of the Lending Game).
The mere existence will save you money
In our experience, merely setting up this banking structure will almost certainly result in a fall in expenditure, probably without any negative lifestyle consequences. But most importantly, it will allow you to track your cash flow at a high level so that you can ‘course correct’ if it gets out of control.
Use the lockdown to reset spending habits
Unconscious behaviour tends to be habitual. Breaking the habit, tends to break the unconscious activity. An unexpected positive from the pandemic shutdown might help achieve this for some.
What if you run out of money?
If you run out of money (spending account balance hits zero) part way through the period, then you know you have been overspending. In this case, you need to have a closer look at your spending habits. This involves allocates each expense into category 4, 5, 6 or 7.
If your overspending is conscious i.e. you are spending too much on deliberate items, try to reduce either the amount per transaction or regularity. For example, if you enjoy eating out, keep doing so but go to cheaper venues. Or if you like fine dining, eat out once per month, instead of once per week.
The temptation is to try and eliminate these types of expenditure in totality e.g. “we’re not going to eat out for 6 months”. But that approach is rarely sustainable. Remember, the aim is to adopt good cash flow management practices permanently, not just for a few months.
Tech you can use
There are a number of apps you can use to track your expenditure at a more granular level. The most popular is WeMoney. It allows you to link your bank account so that it downloads your transactions from your bank and automatically allocates it to predetermined categories. You can set a budget for each category and automatically track your compliance.
The second biggest advantage is it aids financial decision making
Of course, the biggest advantage of improved cash flow management is that you spend less which allows you to invest more.
The second biggest advantage is that you will have more reliable data to base financial decision on. That is, for example, if a client is contemplating a home upgrade and we are determining a budget, we can confidently base our financial projections on their actual expenditure amounts.
Baby steps
In my experience, 90% of people do not track their cash flow. Not doing so almost certainly means that they are ‘wasting’ money on items that give them zero enjoyment, and that is a shame. Hopefully, this blog demonstrates how easy it is to get this under control. Doing so will greatly enhance your ability to successfully build wealth.
Once you’ve mastered your cash flow, if want to have a chat about how to invest your newfound savings, feel free to reach out to us. Good luck.
