How to manage personal cash flow


Managing your personal cash flow means that you look at your income and your expenses in detail. You track the money that is flowing in, and the money that is flowing out on a regular, usually monthly, basis.

How to manage personal cash flow?

  • Ensure, that your income is higher than your expenses, to accumulate savings
  • Build a budget
  • Pay off your debt
  • Build up an emergency fund
  • Invest your money

Read on, if you want to find out, how to manage your personal cash flow in detail. We also have a sample ready for you.


Illustration on how to manage your cashflow.


How to manage personal cash flow

Managing your personal cash flow is all about tracking the money that flows into your account(s), and flows out of your account(s). An easy example of this is when you have a 100% job. Let’s assume you get a monthly income of $7’000. That’s the money flowing into your account.

But then you will also have expenses. You need to pay the monthly rent of your flat, you need to buy groceries, you need to pay for health insurance and car insurance, you need to pay utility bills for electricity and water, you need to pay for your mobile contract, and you might have some online subscriptions (Netflix for example). This is the money that is flowing out of your account(s).

If your expenses are less than your income, you can accumulate savings. And savings is what we need in order to build up an emergency fund, and start investing. Especially when you are a beginner and are just starting out with investing, having built an emergency fund first (cash for worst-case), will give you some security and more courage to invest.

If your expenses however are higher than your income, you will build up debt. If your debt is consumer debt, credit card debt, you took a student loan, or you owe somebody else money, you will need to pay this off first because you need to pay a premium to the individuals or companies, that were lending you the money. If you have invested in non-depreciating assets, such as a house, it might still be possible to invest, as long you can pay your mortgage payments.

If you are in debt, there are two ways to get out of it. Increase your income, or lower your expenses. You can guess, which one is the more realistic one short term. It’s lowering your expenses.

Companies are usually doing the same short term if they get into financial trouble. They might let go of staff, or sell some of their assets. That will usually buy them some time to find new ways to increase revenue and profit.

If you have any possibility to lower your expenses, then this is the first way to go, as it is usually the fastest approach. This might be sufficient already, and you can pay off your debt quickly.

The general calculation you can use to calculate your savings is the following:

SAVINGS = (INCOME – TAX) – EXPENSES

In our example, if you have an income of $7000 a month you first deduct the monthly tax rate. If you have to pay 30% taxes, your net income is $4900 (Income – Tax). Let’s say you have expenses of around $3500. If you now deduct the expenses from the net income, you will end up with $1400 in savings.

Income

  • Job
  • Side-Hustles
  • Other sources of income

Expenses

  • Rent for flat or house
  • Groceries (Food)
  • Transport
  • Mobile Phone
  • Medical expenses
  • Insurances

Tax

  • Income Tax

How to create a budget

There are several approaches you can take to create a budget. From very high level approaches to splitting the money up into diverse categories. But the key here is to keep it simple so that you have a fast monthly routine to put together all the figures.

The 50/20/30 Budget Rule

Senator Elizabeth Warren popularized the 50/20/30 rule in her book “All your worth: The ultimate lifetime Money Plan”. If you’re interested in the details, you can read the article on Investopedia. The 50/20/30 rule differentiates between needs and wants, and adds savings to the mix.

So what are needs and wants?

  • Needs are things that are essential for your survival and wellbeing. For example shelter, food, water, and clothing are the most necessary ones. In the modern world, this includes paying the rent of your flat, paying for water and electricity, and paying for groceries.
  • Wants are things that are not really necessary for survival. You might want an iPhone even though you know, a cheaper Android phone would do it. You might want to travel to an exotic destination for holidays, instead of staying at home. All these things might be important to you, but they are not essential for survival.

Senator Elizabeth Warren suggests, that after deducting tax:

  • 50% of the income should go towards your needs (Rent, Food, Utility & Medical Bills)
  • 30% can go towards your wants (iPhone, fancy furniture, …)
  • 20% should go towards savings or debt repayment, and building up an emergency fund.

So let’s have a look what this means if we have an income of $7000 and a taxation rate of 30% ($2100 go away in taxes each month).

  • Income without taxation: $7000 – $2100 = $4900
  • 50% of $4900 goes towards needs: $4900 * 50% = $2450
  • 30% of $4900 goes towards wants: $4900 * 30% = $1470
  • 20% of $4900 goes towards “savings / dept repayment”: $4900 * 20% = $980

We would however suggest, that if you are in debt, to cut down further on the “wants”, and increase the percentage you put towards “savings/debt repayment”. If you have debt, you need to pay extra interest to the lenders. So while you pay interest, they earn your money. And that’s exactly what we need to change. We need to get onto the side of the coin, on which you earn interest from other people or businesses.

The 50/20/30 rule is just one way to create a budget. In the end, the budget has to work for you so feel encouraged to design your own version. We recommend however to keep it as simple and painless as possible, as you will be doing this on a monthly basis.

Emergency Fund

Before you start investing, we recommend to build up an emergency fund with sufficient cash reserves for tough times, such as when you lose your job or have any other unforeseen extra expenses. Life can be unpredictable and it’s always good to be prepared for such cases.

If you need extra cash you won’t necessarily want to take it out from your investment account, because usually there is a fee associated with taking out your money. Depending on in which country you are, it might also mean that you need to pay tax on the money you take out. That’s why we recommend keeping sufficient cash ready for potential unknown unknowns.

Here’s one way of doing it:

  1. Build up an emergency fund with which you could comfortably live for 6 months, without having a job.
  2. Once step #1 is reached, split your savings 50/50. Put 50% into investments and the other 50% into the emergency fund until you could live comfortably for a year without a job.
  3. Once step #2 is reached, you can put 10-20% towards the emergency fund, and use 80-90% for investments.

If you never touch your emergency fund, and it grows beyond 2 years, you can then easily put 100% into your investments.


Sample savings calculation

Below you see a sample calculation to determine your monthly savings. In the below example, you have an income of $7’400, expenses of $5’240 and when subtracting the expenses from the income, you end up with $2’760 in savings. This is the money, that you can now put towards your cash emergency fund, and then towards investments. In this example, we didn’t count your side hustle against taxes, but depending on the country you’re in you might have to.

Income

Income TypeMonthly Income
Job$7000 ($84’000 taxable income)
Side Hustle$400
Total Income$7’400

Expenses

Expense TypeMonthly Expense
Rent$1’600
Health Insurance$300
Car Insurance$150
Tax$2100 (30% of $7’000)
Groceries$800
Electricity and Water$100
Phone Bill$40
Petrol$150
Total Expenses$5240

Savings

Income – Expenses = Savings: $7400 – $5240 = $2’160

Track your savings

Just as we had a tracker to track our net worth, we also have a tracker for our monthly savings, and how we distribute the money into our emergency fund and investments. In the below example in August 2020, we were still building up our emergency fund and reached the 6 months emergency fund target. So in September and October, we continued to put 50% of our savings into the emergency fund, and 50% we decided to put into a mutual fund.

Year-MonthSavingsDistribution
2020-10$2’16050% Emergency Fund: $1’080
50% Mutual Fund: $1’080
2020-09$1’98050% Emergency Fund: $990
50% Mutual Fund: $990
2020-08$2’040(6 months emergency fund reached)
100% Emergency Fund: $2’040

Conclusion

We have learned, that if we want to increase our wealth, we need savings. We can achieve savings if our income is higher than our expenses. Usually, it is faster to lower our expenses than to increase our income, therefore this should be our first option if you are in debt. We will build up an emergency fund, from which we can draw if we lose our job until we’ve found a new source of income. As soon we have built up our emergency fund, we can put additional money towards investments.


Chris

Chris is an IT Project Portfolio Manager within the financial industry. Due to the nature of his role, he is engaged to study Financial Markets and is an active investor.

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