Making a Cash Flow Statement and Budget

Updated July 28, 2007

Cash Flow Statements

A cash flow statement is simply a list of what you have spent your money on in the past as well as where your income came from. For example, this month I spent $500 on rent and $300 on groceries then transferred $50 from my paycheck into my savings account (that's an expense you pay to yourself), and so forth, and I earned $3000 from my weekly paycheck.

To create a cash flow statement, you need to keep records of what you've spent money on. Keep your receipts, write down all of your banking transactions in your register, use duplicate checks, and pay attention to your statements. Using money management software can help make things easier because you can download information from your financial institutions and import it to your software program, but the old fashioned pencil and paper work too. When recording your transactions, you'll probably want to have the following information for each transaction the date, transaction type (ATM, Cash, Check including check number, credit card, etc.), payee, what the transaction was for, and the amount you spent (or received). Only some of that information will be on your cash flow statement, but the rest of it will be helpful with other situations.

Now put all of your transactions into categories. (See Common Categories) I recommend being as specific as possible. Instead of just having a category for "food," I would have: "groceries," "coffee shop," "cafeteria at work," "happy hour," "other dining out," and so forth. This way you can see exactly where all of that food money is going to, and you may discover that you spend quite a bit of money on something that was just a little weekly treat.

Add up every transaction in each category to get your category total.

At the end of the month, you will have a monthly cash flow statement, listing how much you spent or earned in each category.

Budgets

Now that you have a cash flow statement, you can make a budget.

A budget is simply a cash flow statement for the future. Instead of listing what you have already spent and earned, it lists what you expect to spend and earn in the future.

Before you get started, there are some terms you should know:

• Fixed income: income that is always the same amount each pay period (e.g. salary paychecks, disability payments, etc.)
• Variable income: income that may not be the same amount each pay period (e.g. paychecks from hourly wages unless you work the same number of hours each week, dividends, etc.)
• Fixed expenses: expenses that are usually the same amount each time you have to pay them (e.g. rent, insurance premiums, membership fees, etc.)
• Flexible expenses: expenses that have amounts that vary in relation to how much you use a product or service (e.g. telephone, electricity, entertainment, etc.)

To figure out how much to put in each category just look at your previous cash flow statements. If you spent $500 on rent (a fixed expense) last month, chances are you'll spend $500 in rent next month. If you get $1000 every paycheck (a fixed income), chances are you'll get $1000 in your next paycheck, so figure that in, and if you get approximately $250 every month from mowing lawns on the side (a variable income), you can factor that in as well.

The beautiful part about a budget is that you can decide to change what you expect to pay for something in the future. If you discover that you're spending $50 a month for "happy hour" (a flexible expense) and you want to cut down that expense, you can simply reduce the number of times you go out to happy hour or cut down how much you spend at happy hour during the next month.

There is the matter of infrequent expenses, though. Let's say you only pay your car insurance twice per year. Well, if you didn't pay it last month, it won't be on your cash flow statement, and you may forget to put it on your next month's budget, which is when it is due. There are a couple of ways you can handle such infrequent expenses.

• Spread out the cost of infrequent expenses throughout the year Calculate how much you would have to set aside each month to ensure that you will be able to pay for the next premium. Divide the amount by the number of months between each payment. Example: Category--Automobile; Subcategory--Insurance; Duration--paid every 6 months; Amount--$500. Divide amount ($500) by the number of months between payment (6 months) = Monthly Average ($83.33) In this example, you would have to set aside $88.33 each month to pay for your $500 auto insurance premium, which is due only twice per year, so you would write this amount in your monthly budget. Then take the amount you need to set aside each month for that particular expense and put it in an account that earns interest (such as a savings account). By the time the bill comes around, you'll have enough money saved up to pay the expense, and that money earned you a bit of interest in the meantime.
• Make a budget for every month of the year and fill in those infrequent expenses in the months that they are due If your car insurance is due in January and July, then add it to the January budget and the July budget. The problem with this method is that you still don't know if you'll have the necessary amount when the time comes to pay that bill. Some people who use this method simply look at the budget for the month and say "oh, I have that big bill of $500, so I'll just not spend any money on unnecessary expenses that month to make up for the difference." This does work for some people, but most of us really should be setting aside money each month for these bills.