A company which is listed in the stock market has to publish 3 essential financial statements.
The balance sheet
The profit and loss statement
The cash flow statement
Briefly, the balance sheet shows the health of the company at the reported time, profit and loss statement shows how much profit the company is making after all expenses and taxes, and the cash flow shows how the company is generating the cash from its operations as well as investments.
Free Cash Flow (FCF) is an important metric that is used by investors to evaluate the real worth of a company.
In personal finance, while balance sheet (Your net worth) and profit and loss (how much you are making and spending) are important, managing the cash flow is key to achieve your financial goals.
In this blog, we will talk about how to manage your cash flow – no matter whether you earn a lot or earn an average paycheck.
Most people do not manage their cash flow, forget about doing a budget or any other conscious form of tracking.
At the end of the month or year, we wonder where all the money earned went.
Conventional ways of managing cash flow
There are several techniques Personal Finance experts have championed time and again.
Do a budget, track every dollar.
Create an envelop for groceries, utilities, fun etc.
Use separate accounts.
New automated solutions like Stash, Digit etc.
All of these are good methods, but the problem is sticking to the discipline of maintaining it day after day, month after month.
Isn’t that boring and worrying at the same time? Few issues with these approaches are:
Writing down expenses every day
Stuffing that envelop and counting the money every time before spending
Keeping track of multiple accounts
Not knowing how much the AI driven savings app is going to deduct next month
So is there a simpler and better way?
Just like most posts in this blog, I seek simplicity and automation.
The simpler way of managing your cash flow
There are 4 goals to managing the cash flow every month.
Invest for the future
Save for the short term
Pay your bills
Spend the rest
In fact, any wind-fall is also a one time cash flow, and can be fit into the same framework. Lets say you got a bonus of $1000, for example, the Govt is sending a check to all Americans. And if you want to keep it simple, allocate 25% to all the 4 goals.
Invest $250 in your long term (retirement, child education) plans. The market is down and you can invest $250 in a mutual fund or an ETF.
Save $250 for any short term goals that you have. It could be added to your monthly savings goals, towards anything like vacation, buying that new phone, or simply emergency fund.
If you have consumer debt, why not allocate some to pay it off? Use $250 to pay off the highest interest or smallest balance credit card.
Now you have $250 to splurge on. Buy that favorite book, order the special meal or decorate your home.
But how do we automate and manage the cash flow every month?
Invest – Direct deposit investments. In fact most employers have systems to auto-deposit 401-k investments or direct deposit to your chosen brokerage firm.
Save – Auto transfer to a savings account from your checking account.
Pay Bills – Setup auto-pay with your credit card or debit card. Set the bill payments mostly towards beginning of the month.
Spend – Use your debit card to spend – it will tell you when the money runs out.
Once setup, the only stress you have is the last bullet, where you have to make your spending within the limits, or rather the residue after all obligations are set aside or paid off.
How it can snowball into Financial Freedom
As you get consistent with stashing money away for investing and savings, those may generate additional cash flow or assets which will come back to bolster the spending budget.
Thus cash flow is a virtuous cycle once set up the correct way. Lets take some initials and approach this from a math perspective.
J – Job Income
R – Retirement
I – Investment
S – Savings
B – Bills
E – Expense
P – Portfolio Income
J + P = R + I + S + B + E
Ican produce Pin terms of interest, dividend or rental income.
In the wealth accumulation years, the goal should be to increase J, so that Ican be increased, which when invested can increase P. Pis added to J and a part reinvested, saved or used.
As you reinvest P, it will generate more P till at a point, J becomes less and less important.
This cash flow situation is called Financial Freedom.
We just presented a simple and fully automated cash flow management system for personal finances. It does not take much discipline and will power to stick to it, once correctly setup.
Safety in financial world is an oft-repeated word, and is mentioned in contrast to risk and growth.
We talk a lot about risk-return trade-off, safety of invested principal in long term and short term investments.
There is another way of looking at Financial Safety. The SAFE plan described below is a way of setting up financial life that is SAFE by design, not in the traditional sense of Safety vs. Risk but automatic habits that ensure you don’t stray from common sense.
Common Sense and Simplicity in Financial Plan is hard to achieve. True it is counter intuitive, but most people land into financial trouble due to complicated behavior – be it spending recklessly, chasing high unrealistic returns or simply throwing caution to the wind.
The SAFE Plan
Let me first present the 7 steps to SAFE plan.
Invest in pre-tax accounts like 401k and HSA.
Set up a direct deposit of the remaining taxable income to a checking account.
Set up credit card payment to be auto paid from the checking account on the 30th of every month.
Set up an auto-invest plan where 10-20% of the taxable income is diverted to a brokerage account or another IRA account (like Roth IRA).
Spend your monthly expenses on the credit card. Keep an eye on the credit card balance with the money left over in the checking account.
Save the left over surplus, if any.
Continue and repeat next month …
The above steps are nothing new. They have been suggested by numerous financial coaches and gurus. However the importance of the SAFE plan is how the steps are stitched together and flows through a seamless automation.
Since we have established the Simplicity of the SAFE plan, lets look at the Automation part and how to set this up.
You just need to figure out the % you want to put in 401k or HSA, and inform your payroll department. This can be decided based on the following factors.
Your cash flow needs after this deduction.
How much to invest to capture any employer provided matching contribution.
Max limits of the 401k or HSA.
Direct deposit of the taxable amount to checking account.
This is handled by your payroll department automatically.
Setup credit card auto-pay from your bank account for the 30th of every month.
This one if not done, can prove to be dangerous as missed payments are very costly.
The trigger will also help you pay-off something even if you have amassed a debt.
You can configure to pay off the entire balance, minimum payment or a fixed amount.
Setup auto invest for 10-20% of the taxable income. The exact % can vary as it will depend on your household expenses.
Even if your budget does not allow this today, find at least a small amount ($50-$100) to divert automatically to an investment account.
This will build the habit and set you up for regular investment.
The amount can be increased over time as the budget frees up extra cash.
Live within your means. This is again a cliche, but very difficult to be consistent month after month. You can manage it with some automation and discipline though.
setup a notification when your credit card balance crosses 90% of your projected expense for the month (or simply the money left in the checking account).
Put a Level 5 tornado/hurricane warning when it is crossing over the money left over in your checking account.
Typically the projected expenses can be simply set to the money left over in your checking account. You cannot spend more than that without incurring consumer debt or dipping into other savings/investments.
Save the surplus – If you have surplus at the end of the month (that is, Credit card balance < Money in checking account) you can save it for future goals, short term and mid term.
I wish banks provided this facility, but it can be set up to transfer a fixed amount once you have an idea of your monthly expenses.
Some apps like Acorns or Digit automate this although in more complicated way.
Do not leave the money in the checking account otherwise next month it will create an illusion that you can spend more.
Let the automation run month after month.
Once setup correctly, the basic version of the SAFE plan is low maintenance and enables an almost debt free living.
Of course, we have not taken into account mortgage payments, prior debt pay down, saving for education – but these can also be fit into the plan. In the step where you are investing 10-20%, you will break that into smaller chunks of various debt pay down and remaining amount can be invested for various goals.
Thus the plan is also extremely flexible to adapt to individual situations.
The last part of the SAFE plan is that it is efficient in managing money.
The following good principles are built-in into the plan.
Pay Yourself First – Pre and Post Tax investments are deducted in the beginning.
Low maintenance – no coupon cutting, daily budgeting etc.
Keeps you debt free – just keep tab that your credit card balance is below money left over in checking account.
Encourages more savings at the end of the month – creates a healthy race to increase it, by reducing your spending.
The efficiency is evident if you do this for even one year. You will see the difference in your credit score, savings balance, net worth and above all, peace of mind.
This plan has been working for me for a long time. The simplicity and automation helped me manage it seamlessly without getting distracted from my main job – which is not finance.
And the in-built savings and investment discipline in the plan has helped me invest and accumulate cash for emergencies, short term purchases or just a cash cushion.
Here is my version of the 7 steps of the SAFE plan (the % are approximate and rounded)
Invest some in the Roth-401k and H.S.A.
Direct deposit first paycheck. (50% of monthly)
Use the credit card from same account. Set up auto-pay on 30th of every month.
10% to mortgage account
10% to savings for property taxes, insurance and maintenance
20% invest in mutual funds via brokerage account
10% to a 529 Plan
Next paycheck direct deposit on 15th of month. (50% balance monthly paycheck)
Living expenses capped to 40-45% of monthly total.
Pay off credit card balance within this limit – I make sure it is $0 as it enters following month.
Sometimes it is hard to stick to the limit, then I have the cash cushion (from previous months’ savings, step 6) to dip into.
5-10% savings for vacation/travel, fun, cash – diverted to a high-yield online savings account.
There are many articles on how to be frugal, how to save more, earn more and invest for high returns.
All this is good advice, and the Internet is full of such articles, blogs, videos, courses.
However the key to saving money and investing for growth is action and the discipline to implement the good practices.
If you go through most of the articles, some common themes emerge such as:
Pay yourself first
Do a proper budget or at least allocate money to your various expenses
Big tax refunds are not cause to celebrate
Get out of debt
Regularly invest a little
Use Robo advisors
and so on…
Yet lot of people (some say 78% of Americans) live paycheck to paycheck, and will not be able to cough up $400 cash in times of emergency.
With so much of good advice and technology out there, why then we still have the problem with more than 50% of the population? What is different with the 10-20% who manage to create and keep wealth?
I think the answer lies in being organized, intentional and disciplined. As Dave Ramsey said “Personal Finance is more behavior than numbers”.
It requires a system to be organized and manage your money. Once the system is in place and you get into the habit of it, you will automatically resist impulsive behavior.
In this post, I will highlight some of the systems that I follow to organize this area of my life. And remember, the more organized and intentional you are on personal finance, it impacts rest of the areas of your life as well. Cliche, right? Yes but difficult to implement.
There are 5 parts to the system:
Just for fun, lets rearrange and call this the CARLA system (Cap, Automate, Remind, Learn and Archive). Really the order does not matter.
Automation is the heart of any system. And with most of the financial products employing high end technology, there is no reason to avoid automation.
A simple automation makes the “Pay yourself first” a breeze like operation.
For example, in my case, the first bi-monthly paycheck (pre and post tax) simply goes to my mortgage and investments (retirement, 529 plan, HSA, investments). I just cannot see it in my checking account by the 2nd or 5th of the month.
How do I run my expenses and pay my bills then? Another automation.
All my bill payments are set on the one and only credit card that I use. It is completely automated so I don’t need to remind myself to pay electricity, water or phone bills. The same credit card is used for first half of the month to buy essentials.
By the same system, the second bi-monthly paycheck pays off the credit card bill in full.
A portion of that also goes into savings for short term goals (provided the credit card was not overused – we will talk about caps in next section).
Naturally implements the Pay Yourself First.
Automated bill payments, so no chance of forgetting and running into credit problems.
Earn points on the credit card, as all expenses are charged to the one.
The credit card is automatically paid off within the month.
Need to control expenses as the credit card balance should not overshoot the projected amount.
Unexpected debits to the checking account (checks issued, or charged by institutions) may cause overdraft scenarios if not careful or kept track of such expected transactions.
One of the toughest part of personal finance behavior is to cap your spending. No amount of technology or automation can address this adequately. There are budget apps, reminder apps, envelope system but at the end of the day, if you are armed with a credit card, there is no stopping you.
There are two ways to address this:
If you are using a credit card, then absolutely you will need a budgeting and expense tracking app. I use YNAB (You Need a Budget) but I have heard people liking Mint or Personal Capital. In these apps, you can set limits for spending under each category like Food, Transportation, Utilities and Fun. Here is a referral link to YNAB.
However a more effective way and not to run into debt, you can automate to transfer the estimated monthly expenses to another checking account, and use the ATM/debit card of that account. As soon as you see the account is drying up, you know you have to rein in your spending. As you do this more, you will slowly understand the pattern and be able to make or adjust estimates.
Having a cap of expenses is non-negotiable in the pursuit of good personal finance habits.
You know exactly where each dollar is going and how to optimize or reduce the outflow.
The first approach definitely has the risk of running into credit card debt, and not able to pay in full.
The second approach is safer but if you are not keeping track, can hit you with overdraft fees or embarrassing card decline at the checkout counter.
A good archiving system is also key to good personal finance habits. Not only habit, but it keeps you stress-free. Remember the scrambling during tax filing season, looking for bank statements, dividend results, interest certificate etc.
Moreover we have multiple sources of information, statements coming through email, snail mail, website downloads, or even previously archived repositories.
A simple system I follow consists of a uniform folder structure across multiple sources of information.
There are 4 aspects of personal finance that you need to keep track of.
Bills and Receipts – Miscellaneous bills and receipts if they do not fall into above categories.
With the above organization, you can simply create the archival system in all your information sources.
Gmail – create these as labels or email folders.
Evernote – you can create notebooks and store documents as notes under each notebook.
Google Drive – create folders. You can save attachments from gmail directly to these Drive folders.
Laptop local drive – Sometimes it is best to store in the local drive than cloud. That is, if you are uncomfortable storing documents containing sensitive information (SSN, date of birth) into the cloud. Be sure to periodically back this up into external hard drives.
Physical documents – Paper statements can be either scanned and stored in above places, or simply dropped into file cabinet drawers, with appropriate labels. The labels should follow the same categorization.
Once you have the uniform structure across all these platforms, storage and finding information is easy.
Easy to file and find.
Following same structure in all systems that you use.
None at all.
So you have automated, capped and archived personal finance. But what about still those actions to be taken, follow-ups to be done and making sure time sensitive things do not fall through the cracks?
I don’t want to describe personal productivity or time management here, but an essential part of managing personal finance is timing. There are taxes to be paid quarterly, investments to be made, or simply a phone call to be made.
Choose whatever system works for you as reminders, be it an app on your phone, or calendar on the laptop.
For me, plain gmail works as it has a snooze facility, by which I can redirect any email to come back to my Inbox at the time I need to take action. In my opinion, it is an important tool in time management as now I can remember to take action at the right time. It just pops in my Inbox on that Sunday prior to the week I need to take action on that.
Another good platform for keeping track of your laundry list is Trello. I use it quite extensively and the concept of board and cards, helps keep things visually clear.
Even if you automate everything, there will be things for which action needed to be taken timely.
Remain stress free and auto-magically respond or follow-up with people at the right time. Sometimes this surprises people as they may have promised to do something (or get back to you) and you follow up on the agreed date.
Unless you stick to one system (Trello or Gmail), you run the risk of multiple apps keeping track of your to-do lists and confuse you enough not to take action or update new items.
You may run the risk of irritating some people who do not like to be followed up, especially if they wanted to forget what they promised.
I cannot emphasize this enough and with the plethora of information on the Internet, whatever I say will sound like cliche.
However as with any field, it is important to keep yourself up-to-date with advances in personal finance topics.
One of the simplest ways is to dedicate a couple of hours every week, to read about different topics, blogs and videos of personal finance. You can subscribe to magazines like Money or Kiplinger. Or simply come back to this blog as I normally post every week.
Learning is always good, and opens up new opportunities for you.
You build your own system and strategy as you read and learn techniques others have used.
Don’t get obsessed by personal finance reading, as it can get repetitive very easily. You may end up wasting lot of time reading the same message in different ways.
You may take wrong action or jump into investments without fully understanding the consequences, or simply following some author’s thumb rule from a book.
These are the Five essential elements of a good system that can be setup with minimal infrastructure. It worked for me and I hope you find it useful.
My CARLA system (Cap, Automate, Remind, Learn and Archive) – a system to automate, manage and grow personal finance.