By: Reed C. Fraasa, CFP®, AIF®, RLP®
As we embark on a new year, there's no better time to take control of your financial future by thoroughly reviewing your cash flow. If having a vision and establishing goals is the touchstone for a financial plan, this essential financial practice sets the foundation for achieving your goals and ensuring long-term financial stability. It doesn't matter if your spending plan is $100,000 a year or $1,000,000 a year; cash flow management and monitoring are critical. That's not to say that you need to be on a budget and count every dollar, but you need to be aware of everything that comes in and what is going out to make good decisions.
Understanding Your Current Financial Position
The first step in reviewing your cash flow is understanding where your money comes from and where it goes. Start by gathering all your financial statements from the previous year, including bank statements, credit card bills, and investment accounts. This comprehensive view lets you identify patterns in your spending and saving habits that might have gone unnoticed during the busy year.
If you have a complex financial system of multiple bank accounts and credit cards, make this the year you simplify things and consolidate the accounts down to one linked checking account and one high-yield savings account. Also, most people do not need more than two credit cards.
Creating an Effective Cash Flow Framework
With your financial data, it's time to create a structured cash flow plan that aligns with your goals. Begin by categorizing your expenses into fixed costs (like rent, mortgage payments, and groceries) and discretionary spending (entertainment and dining out). This categorization helps identify areas where you control your spending most.
Further, group your expenses around large items like housing (all the costs of maintaining your home), healthcare, mortgages, and other debts. This is important to know should you ever consider relocating or reducing debt.
Implementing Tracking Systems
The success of any financial plan hinges on consistent monitoring. In today's digital age, numerous tools and apps can help you track expenses in real-time. Whether you prefer a sophisticated budgeting app or a simple spreadsheet, choose a system you'll use.
A simple system is to set up a floating balance target for your checking account (3 months of living expenses) and then deposit all your income items (salaries, social security, pensions, etc.) into the high-yield savings account. Transfer the amount you have budgeted to spend each month to the checking account based on your cash flow. Remember to always pay yourself first by funding retirement or investment accounts until you retire. Then, you only need to monitor the balance of your checking account at the end of each month. If you see the balance reducing over several months, you know you are spending more than you thought, and if it is increasing, you know you are spending less. Ideally, the balance will fluctuate slightly but be close to the starting balance at the end of six months.
Making Strategic Adjustments
As you analyze your spending patterns, look for opportunities to optimize your cash flow. This might involve negotiating better rates for regular services, consolidating subscriptions, or finding more cost-effective alternatives for frequent purchases. Remember, minor adjustments can lead to significant savings over time.
Consider setting up automatic transfers to savings accounts on paydays before you can spend the money. This "pay yourself first" strategy ensures that saving becomes a priority rather than an afterthought.
Planning for the Future
Your cash flow review should extend beyond immediate expenses to include long-term financial planning. Set aside time to review and adjust your emergency fund, retirement contributions, and other investment strategies. Consider whether your current saving rate aligns with your future goals and make adjustments accordingly.
Consider anticipated changes in the coming year, such as salary increases, new financial obligations, or planned significant purchases. Building these into your cash flow plan helps prevent financial surprises and prepares you for what lies ahead.
Your annual cash flow review is more than just a financial exercise—it's an investment in your future security and peace of mind. By taking the time to understand, plan, and adjust your financial habits at the start of the year, you set yourself up for success and create a strong foundation for achieving your financial goals. Remember, financial planning is not a one-time event but an ongoing process of review, adjustment, and improvement.
Reed C. Fraasa is a CERTIFIED FINANCIAL PLANNER™ and founder of HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Reed has 30 years of experience as a fiduciary advisor and is the author of The Person is the Plan®, a unique financial planning process. Reed was a frequent guest contributor on PBS Nightly Business Report and has been featured in the New York Times, Wall Street Journal, and Star Ledger newspapers.