A Cash Flow Plan (budget) is the single most powerful personal finance tool anyone can use for wise money management. But this is not a one-size-fits all proposition; there are different planning and tracking systems, each with its own advantages. Here are the options, along with my recommendations as to who would benefit the most from each one.
The Envelope Budget System
This system is best for people who prefer to use cash whenever possible but also pay some bills online. It’s also a great system for those who do not have much money in reserve.
Each time you get paid, fill envelopes with the amount of cash you have budgeted for specific spending categories until the next time you’re paid. For example, if you get paid once a month and have a $400 monthly grocery budget, each time you get paid put $400 in cash into an envelope marked “Groceries.” When you go grocery shopping, take that envelope with you, pay for your groceries with the money in the envelope, and put the change back in the envelope.
Of course, you won’t want to use an envelope for every spending category, like your mortgage. But envelopes work really well for categories like food, clothing, dry cleaning, gifts, entertainment, home maintenance, gasoline, vehicle maintenance, and miscellaneous.
When you’re out of money in a certain envelope, you’re done spending in that category until your next payday. If there’s any money left over at the end of a period, keep the money in the envelope so you have more to spend over the next period. This is especially important for categories like vehicle and home maintenance. Some months you’ll spend little or nothing in these areas, but other months you’ll have to spend a lot, so you’ll be glad the money has been accumulating.
The Paper-And-Pencil Budget System
This is best for people who use a combination of cash and debit/credit cards, pay some bills online, and have some money in reserve.
Using the forms on my web site, and referring to the Budget Quick Start Guide, complete the Cash Flow Plan. Then, in the “Goals” row across the top of the Cash Flow Tracker, enter your income and expense goals from the Plan.
Track your spending by keeping receipts or by writing down how much you spend during the day and then enter that information on the Tracker at the end of each day.
At the end of the month, total up each category and then indicate how much over or under your actual spending was compared to the goal. Since you will use one form for each month, look at the previous month’s Cash Flow Tracker to see how much over or under you were up to that point in the year, and enter that on this month’s form. Then total up how much over or under you are for the year.
The Electronic Budget System
There are three different electronic budget systems.
An Excel spreadsheet budget. This is best for people who like the layout of the paper-and-pencil system but prefer to use an electronic tool.
On my website, you’ll find downloadable Excel spreadsheets formatted just like the paper-and-pencil Monthly Cash Flow Plan and Monthly Cash Flow Tracker. This can simplify some aspects of the paper-and-pencil system by totaling your columns automatically.
Budget software. This is best for people who are comfortable downloading financial transactions from their bank and credit card companies and like detailed reports about their finances.
Software programs can download your checking, savings, and credit card transactions through an online connection with your bank and credit card companies. It can also download the latest information from your investment accounts. Quicken is the main game in town, but two other software programs that have gotten good reviews are Mvelopes and You Need a Budget.
One downside to budget software is that it’s tied to one computer. Another is the cost. To overcome these issues, you might consider the third category of electronic tools.
Online budget tools. These are best for people who are comfortable doing online banking, prefer to have their budget available online, and don’t need a ton of detail.
The first step in using an online budget tool is the most unnerving for the uninitiated: You have to enter your bank and credit card account numbers and passwords. The leading providers know that people’s number one concern is security, so they go to the nth degree in making sure their systems are secure (I wrote previously about this in an article entitled, “Is Mint.com Safe?”). Still, if you’re not comfortable with this, use one of the other systems.
Once you are set up to allow the service to access your records, it will download your latest transactions automatically. It can also be set up to automatically categorize certain transactions for you, which can save some time. For example, if you do most of your grocery shopping at Safeway, you can instruct the system to categorize all Safeway transactions as groceries. You can also go in and manually make adjustments, such as when you get cash back or pick up a prescription.
Where to Start
If you’re new to budgeting, I recommend that you start with a manual system like the envelope system or the paper-and-pencil system for at least the first year. This will give you more of a hands-on feel for the budgeting process. Once you get comfortable with budgeting, you could switch to an electronic system.
No matter which system you use, remember to use my Recommended Spending Guidelineswhen deciding how much to allocate to each category of your cash flow plan.
Which budget system do you prefer and why? Please leave a comment below.
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