By Julie Cazzin, with Allan Norman
Oct. 29, 2021
Cash flow is key to making your lifestyle goals possible and achieving financial freedom. If you get it right, you have money to invest, borrowing becomes easier, you can get the proper amount and type of insurance, and it puts you in control.
If you are having trouble managing your cash flow or are looking for a few tips so that you have extra money at the end of the month, here is a quick “how to” without all the fluff, based on things Allan learned through the Certified Cash Flow Specialist program.
Step 1: List all your assets
Get a piece of paper and list all the things — such as food, entertainment, gas, mortgage, insurance, etc. — you spend money on and the amount.
Step 2: Classify your expenses into two buckets
The working cash flow (WCF) bucket includes things such as mortgage/debt payments, housing and vehicle expenses, investing, insurance premiums and education costs. These are things that get you ahead, there is no risk of overspending and no emotional pull to spend more. They are often fixed payments and can be paid in easy-to-automate payments.
The active cash flow (ACF) bucket includes expenses for entertainment, vacations, groceries, pets, clothing and children. These expenses are often variable and for things you want, but don’t need. There’s an emotional pull to spend more and it’s also difficult to automate payments for them.
If you are not sure how to classify something, ask yourself if there is a chance you could talk yourself into spending more on a particular expense. If there is, then it is likely considered an ACF expense.
Now, add up the total cost of all your WCF expenses and convert it into a weekly total.
Step 3: Calculate your weekly pay after taxes and expenses
If you are paid biweekly, multiply your pay by 24 (weeks) and then divide by 52 (weeks). If paid twice a month, multiply by 26 (weeks) and divide by 52 (weeks).
If you are self-employed, estimate your yearly income and subtract your estimated expenses and average tax. Use this calculator to find your average tax rate by entering your anticipated income after expenses. Once you have an estimate of your annual income, after tax and expenses, divide by 52 to get your weekly income.
Step 4: Determine your recommended ACF spending
Depending on your financial circumstances, you might spend 20 to 35 per cent of your take-home pay on ACF expenses. For example, a household with a weekly take-home pay of $2,000 has $400 a week to allocate to such expenses based on a 20-per-cent threshold.
Step 5. Find extra money
Subtract your weekly WFC expenses from your weekly take home pay. Let’s say your WFC expenses are $1,000. That leaves you $1,000 if your weekly pay is $2,000 as in the example above. Now, subtract the recommended ACF of $400 from $1,000. The remaining $600 can be used to build extra wealth or make lifestyle investments, depending on your circumstances.
Step 6. Automate the process
Set up two bank accounts. Your pay will go into what we will call your WCF account. Set up a weekly transfer from your WCF account to what we will call your ACF account. Using our working example, $400 will be transferred each week into the ACF account, which is where you’ll be spending from.
You can use a debit card on your ACF account, but don’t attach a credit card to it. If you are a spender, or need to get your spending under control, don’t use the debit card at all. Only use only cash until you get a handle on your spending.
Meanwhile, set up a credit card on the WCF account that is automatically paid off each month.
Allocate the weekly $600 of found money to paying off debt, investing in a registered retirement savings plan, buying insurance, and/or saving for a family vacation or other lifestyle expenses.
Initially, it takes a bit of work to set things up, but once that’s done and automated, it is easy to run and keep you on track.
If you want some help implementing this system you can work with your advisor.
If this system seems a little complicated, just remember the main principle is to restrict your access to all of your cash flow.
Lynn Roberts and Dennis Webb in their book, Uncommon Cents: Benjamin Franklin’s Secrets for Achieving Personal Financial Success, provide a good analogy. They describe a running river that may go dry, so to get control and ensure you always have water, you should build a dam and create a reserve.
If you do it right, your financial goals will likely never have to take a backseat to your current spending.