Week 5 - How to reconcile your budget (Part 1)

Written by Sam on June 15, 2010 – 9:30 am -

Why is reconciling your budget so important?

This week we come full circle in the budgeting process. In week 3 I showed you how to create a budget. It’s time to reconcile your budget. In many ways reconciling your budget can make or break the whole process. If your budget doesn’t reconcile properly and you don’t connect one month’s budget to the next, much of the benefit of budgeting disappears. That’s because budgets that don’t connect don’t hold people accountable and therefore don’t result in a change of behavior. Without connecting your budget from month to month your dollars are slipping through the cracks instead of being powerfully focused to reach your goals.

“Well what if I’m under budget? Then reconciling doesn’t matter does it?”

You bet it matters. In fact, coming in under budget can present a dangerous illusion because you feel so good that you stayed within your spending and then get lazy. If you don’t account for the left over dollars, they will disappear. If they disappear you get no benefit. In contrast, if you consciously redirect those extra dollars, you can accelerate reaching your goals. You’ll reach them faster than you ever thought possible.

On the reverse side of the coin, if you’re over budget you have to ensure that you determine where the overspent money comes from to make sure you’re not unknowingly going further into debt. It has to either come from another category or be made up for in next month’s budget. If not, you’ll either be digging into your savings or going into debt for that overspending.

Now that you’re clear as to why it’s so important to reconcile your budget the right way, let’s get started.

Overview

Here’s a brief overview of the process you’ll go through and how much time you can expect to take.

  1. Update transactions in your accounting software (YNAB, Quicken, or Excel). When you first start budgeting this step will probably take anywhere from 45-75 minutes. The amount of time spent can vary wildly and will decrease dramatically as you follow my tips below. Eventually you should be able to get it down to under 15 minutes.
  2. Verify your software matches reality. In this step you’ll compare the balances of your software and bank accounts to make sure they match. Sometimes this step is not as easy as it seems. 5-15 minutes.
  3. Review last month’s budget and identify where you were over and under and how you will deal with these amounts. 5-15 minutes.
  4. Create this month’s budget using the information from step 3 and based on this month’s needs. 5-10 minutes.
  5. Review and sign the budget with your spouse. 5-15 minutes.

The longest part of this process BY FAR is step number 1, updating transactions in your accounting software. If you follow the hints outlined below and in my podcast 10 Secrets to Budgeting Success you can dramatically reduce the time spent on step 1 and therefore your overall time budgeting. The last step can also be painful and time-consuming at first because you have to work out priorities and differences of opinion. But after a few consistent months of budgeting it can become one of the shortest steps.

Step 1 - Update transactions in your accounting software

In this step you need to download or manually enter your transactions for the previous month into your budgeting software. In the rare instance that you enter all your transactions on a daily or weekly basis, you can skip this step.

The secret to doing step one FAST!!!

As I talked about in week 4, one of the reasons this step can take so long is due to the large number of transactions created by budget categories like “groceries,” “household,” or “eating out.” Not only do these transactions represent around 75-95% of all your transactions, they are the hardest to deal with. Trying to figure out which category that Wal-mart purchase should be under (was it household, medical, or grocery?), and trying to track down receipts can be an agonizing and time-consuming process.

Using cash in your budget for this small handful of categories is the best way to decrease the time spent during the reconciling process. Instead of 20 or 30 tricky transactions, you’ll have just one - a cash withdraw. In addition, using cash has a huge side benefit of preventing overspending. If you missed week 4, be sure to read why I think everyone should implement at least a partial cash budget

Using YNAB

If you’re using You Need A Budget (YNAB), you can watch the screencast below to see how to import transactions from your bank account into YNAB. You will have to download your transactions for the relevant period of time in the “.OFX” or “.QFX” format (sometimes called Money or Quicken files). If you’re bank doesn’t support those formats, you can download the “.QIF” format. Most all financial institutions should offer the ability to download transactions in these formats.

Once the file(s) are downloaded, open YNAB and select “File –> Import Transactions” and follow the instructions. You will have to choose what account the transactions are downloaded to and may have to match transactions together if they were previously entered.

I’ve created the screencast below showing this process and how YNAB deals with a couple different transaction situations.

Using Quicken

If you’re using Quicken, you should be able to automatically connect Quicken to your financial institutions to update. If the institution doesn’t support automatic updates, you should be able to download a file from their web site and import it into Quicken. Quicken’s website and support materials should help you through the process if needed.

Using Excel

If you’re using Excel, you can either enter transactions in manually or download your transactions in a “.CSV” file format and copy them into your working register.

Categorize your transactions

Once all the transactions are imported, go through and make sure each transaction is categorized. Doing so is a necessary step so you can see where you were over and under in your budget. YNAB and Quicken can automatically categorize some transactions for you. Where applicable, both programs will prompt you and ask if you want the program to automatically categorize for you.

Now that you’ve got your transactions in order, let’s test the numbers to make sure everything’s accurate.

Step 2 - Verify your software matches reality.

All your transactions are now entered and categorized. Next we need to make sure your software matches reality. This can be a frustrating process because if things don’t match up it can be like looking for a needle in a haystack to find what’s wrong. Don’t worry. I’ll give you some hints to make the process easier and less frustrating.

Select a date and compare balances

First you need to pick a date on which you want to match things up. This is important and frequently overlooked. You want to match up your accounts “as of” a certain date. You’re taking a snapshot of your finances, much like when creating a net worth statement (see How to create a net worth statement).

Next you want to compare balances. Be careful because both your software and your bank may show multiple balances for each account and you want to be sure to use the right ones or you’ll be hitting your head against a wall for nothing. See tip #2 below for more information.

The balances don’t match. Now what?

If your balances don’t match check the following:

1. Am I looking at the same “as of” date?

Let’s say it’s July 5th and I’m trying to reconcile my budget from June. If I look at today’s balance on my bank’s website I’ll get the wrong figure because the balance will reflect transactions in July as well as June. Most banks will show a running balance for every transaction. In this case you’d look at the last transaction of June and look at the running balance after that transaction and THAT’s the correct number to compare.

Here’s a tip. I usually download all my transactions through today’s date and compare balances as of today. It just simplifies the process. If it’s July 5th and I’m reconciling June’s budget it doesn’t matter that I’ve downloaded more transactions than needed. As long as the balances match up AS OF July 5th I’ll know that June’s transactions are entered correctly. Then next month I’ll just download the transactions from July 6th on.

2.Am I looking at the right balance figures?

As I mentioned above, both your budgeting software and your bank account may show multiple balances and you need to know which ones to use. Otherwise you may actually have matching balances but think that they don’t match because you’re looking at the wrong figures. How frustrating is that?

An example of different bank balances

For any given account my bank shows the prior day’s balance, the current balance, and the available balance. Which do you use? The prior day’s balance and the current balance are self-explanatory. After a little searching, I saw that the “available balance” reflects transactions that have already occurred, but haven’t posted on my account yet. These transactions weren’t included in the file I downloaded from my bank. So, if I were trying to reconcile my account as of today, I would want to include those transactions since they occurred before today. In this case I would need to manually enter them into my budgeting software since they aren’t included in the downloaded file. I would then compare the balance in my software with the “available” balance from my bank.

An example of different YNAB balances

YNAB shows a “cleared” balance and a “working” balance. The “cleared” balance reflects all the transactions that were either downloaded from your bank or manually marked as cleared. The “working” balance reflects all transactions in the account both cleared and uncleared. If, for example, you set up YNAB to automatically enter transactions into the register, they will show as “uncleared” until you download the actual transactions from your bank and they are matched up.

To see how to read balance figures in YNAB, view the screencast below.

3. Are there duplicate transactions?

One of the most common reasons balances don’t match is that a transaction was accidentally entered twice. Every software tool I’ve used allows you to either sort your register by the transaction amount or run a report that sorts by amount. You can then quickly look at any transactions of the same amount and see if they’re duplicates. Delete any duplicates you find. Be careful not to delete legitimate transactions that are the same amount such as recurring bills.

4. Was a transaction entered into the wrong account?

If more than one account balance doesn’t match up, you may have entered a transaction into the wrong account. This is likely to be true if both accounts are off by the same amount. For example, let’s say the checking account balance in your software doesn’t match your actual balance by $6.43. Well if your savings account balance is also off by $6.43 you probably just mis-entered that transaction into the wrong account. By the way, this rarely if ever happens if you only download transactions from your financial institution rather than entering them manually.

5. If all else fails, give up

It’s hard for me to just give up on finding the error, but sometimes it’s the best option. You don’t want to do this on a regular basis or if the difference between balances is very large. If you’re consistently having a problem matching up you’re probably doing something wrong or not following the guidelines above and should try and get to the root of the problem. However, there have been times where I’ve searched for hours to find what’s wrong to no avail. It’s just not worth it.

Instead, enter a transaction correcting the difference in balances and put a note in the “memo” field explaining the problem. Often you’ll come across the error months later and have a big “ah ha” moment. You can then fix the error and remove the “correction” transaction.

I know doing this goes against my basic principle of accounting for every dollar, but as long as it’s not a persistent problem, you’ll be ok in the long term.

Conclusion

So now you should have your transactions downloaded, entered, and categorized and you’ve confirmed that the balances match between your software and your actual financial institution. Life is good. In my next post it’s time to do the fun stuff and see the outcome of last month’s budget. This is where the power of your budget lays. Stay tuned.


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Two Common Objections To Using A Cash Budget

Written by Sam on May 3, 2010 – 11:57 am -

People have a big resistance to using cash in their budget. We’ve become so accustomed to using debit and credit cards that using cash is like a novelty. I wanted to address a couple of the concerns people have and why they don’t outweigh the huge benefits of using cash.

Objection #1: It’s Inconvenient

One of the main objections I hear about cash is that it’s inconvenient. It’s true that using cash may take a little longer than using credit cards. In fact, the credit card industry is well aware of this and emphasizes this point. Have you ever seen the TV commercial with graceful music playing as people use their credit card to check out. Suddenly someone pulls out cash. The needle scratches and the music stops as the person fumbles around with their money and all the other people look on disapprovingly.

That commercial presents a powerful emotional image.

The fact is, cash isn’t that much more inconvenient. In fact, some cash transactions are faster than credit card transactions. Even more important, you want to remember the effect using cash will have on your budget. Think of all the time and pain avoided by not overspending and not having to agonize every month while trying to reconcile your accounts. That pain is much worse than the slight inconvenience caused by using cash.

Objection #2: My cash might get lost or stolen

First let’s talk about cash getting lost. There is no more chance of you losing your cash than there is of losing your credit cards and/or other items in your purse or wallet with that accompanying inconvenience and risk.

To prevent getting your cash stolen, you do want to be careful not to flash around gobs of cash. It’s helpful to have cash in envelopes for this purpose. It allows you to just use the cash you need. You can also make the cash ready and easily accessible before you go into the store so you don’t have to flip through all of it in the store. To do so, take out the money you’ll be using and put it in a convenient and easily-accessible pocket separate from the rest of your cash. No one will be the wiser.

Emily misplaced some of her cash one month and while that’s never a welcome occurrence, it’s much better to lose a couple hundred dollars once than to perpetually overspend $500 every month like we were doing before switching to cash. This was a one-time occurrence in the 5 years since we’ve been using cash.

One more suggestion that could help prevent lost or stolen cash is to withdraw money from your bank in chunks. Instead of taking all the money out once during the month, take half out at the beginning and half out mid-way through the month. This minimizes the possible amount you could lose if that misfortune occurred.

Try it to believe it

In the end, some people have to try using cash to really experience the benefits and become converted. You can come up with excuses all day about why you shouldn’t use cash. Go ahead and do that and I’ll talk to you in a year and find out that your budget still doesn’t work and you’re still living paycheck to paycheck.

I personally was a big skeptic and only saw the huge benefits of cash after doing a cash budget for a few months. Now I’d never go back.


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11 Guidelines For Using Cash In Your Budget

Written by Sam on April 30, 2010 – 11:26 am -

1. You don’t have to use cash for everything. Here’s how to tell in which categories you should use cash.

To reap the benefits of using cash in your budget, you don’t have to go exclusively to cash. Some may choose to go exclusive, but it’s not necessary. Instead, identify which categories will be most effective for using cash using the tips below.

Use should use cash for categories where either you tend to overspend or where there are a lot of transactions in a month. Groceries is a main perpetrator of both those criteria which is why I absolutely recommend funding that category with cash. Other problem categories are ones relating to household spending (light bulbs, cleaning products, etc), eating out, personal, and entertainment.

There are actually some categories where it is easier to NOT use cash. Specifically I’ll mention gas for your car. At first Emily and I used cash for gas but found it to be significantly more inconvenient, especially during the winter. After looking at our gas spending we realized that we don’t tend to overspend on gas. Our gas budget went up and down depending on the price of gas, but we weren’t more likely to drive less by using cash. I still had to commute to and from work no matter what and we don’t take a lot of trips. Gas purchases also weren’t hard to track in our financial software. We knew that if the transaction was at Texaco it was gas so it didn’t add any confusion at the end of the month. In the end we decided that it wasn’t worth it to use cash and now use a debit card.

Some categories are on the edge and could go either way. For example, haircuts is a category that I think should not be cash, but Emily likes it in cash. From my perspective it’s not hard to track haircut transactions. A transaction at SportsClips is self-evident. There aren’t a lot of haircut transactions. At most I will get one and Emilyi will get one. I’m also not likely to overspend and get haircuts more often if I’m not using cash. For me, this category doesn’t need to be in cash.

For Emily that’s not the case. She is more likely to get a haircut or styling if there’s money available for it. She also will let money accumulate from month to month and then get her hair colored with the extra money. She likes having the money in cash because as it accumulates it gives her permission to do something extra without guilt. Therefore, Emily prefers to have this category in cash.

In the end we do our haircut money in cash, but we could just as easily split the category into “his” and “hers” and do one in cash and the other not.

2. You have to commit for cash to work.

When starting to use cash for chosen categories, you have to be willing to totally commit. If you have some transactions in cash and some on credit/debit card at the end of the month, you’re going to run into the same headaches you’ve always had. This means that ideally both spouses are on board. If your spouse resists, see if he or she is willing to give it a try for just a month.

This also means that if you go to the store and forget the cash, you won’t make any purchases until you go home and get it. That’s the level of commitment it takes. I’ll admit that on rare occaisions Emily or I will break down and use the debit card, but it’s usually only if we’re far away from home and are buying something we can’t get close to home. Even then, we’ll try to borrow cash from other places first. One of us usually has some personal money with us and so we can use that cash and then get paid back from the correct category when we get home.

3. Calculate what denominations to withdraw ahead of time.

When withdrawing cash, you’ll likely be pulling it out for multiple categories at once and you’ll want to make sure you have money in the right denominations to easily fund each category. For example, if a category needs $50 and the bank only gives you your money in $20 bills, it will create an inconvenience to then have to get smaller bills.

This problem can be easily avoided by figuring out ahead of time what types of bills you need ahead of time and then requesting those bills from the banker.

4. How to keep track of my cash

There’s no right way to store and keep track of your cash. The most common method is to use envelopes.

There are three types of envelopes you can use.

  1. Regular envelopes from an office supply store. Unfortunately they don’t have sizes customized for cash so you’ll have to find the closest size that fits.
  2. Envelopes your bank gives you when making a withdraw. These are still a little large for my taste, but are smaller than regular envelopes and are free. Don’t be shy about asking for an extra envelope or two when making a withdraw.
  3. Custom budgeting envelopes through Dave Ramsey. These are great, but cost a little extra. There are two different version which you can find using the links below.

Financial Peace University Envelope System
Deluxe Executive Envelope System

We have altered how we manage our cash from time to time. Sometimes we have an individual envelope for each category. Sometimes we keep all the cash in one envelope divided by index cards or post it notes. Feel free to experiment and find a way that works for you.

For men, using paper clips can be an easy way to separate your cash into categories. Often men won’t have as many categories as women so this is manageable. You can buy multi-colored paper clips and use a color for each category. You could also cut out a small piece of paper, write the name of the category on it, and stick it in the paper clip with the corresponding cash.

Feel free to leave any comments or ideas on your favorite way of managing cash.

5. Pull out grocery twice a month if you need to pace yourself.

A common problem, particularly when first starting to use cash is to spend too much money in the grocery category too quickly. You may be excited to have all that cash in hand and go overboard on your first shopping trip. Then, you end up on the 20th with no cash left.

To avoid running out of money prematurely, you may want to take out only half the grocery money at the beginning of the month and the other half mid way through the month. This helps you pace yourself and ensures you don’t run out of money with too much month left. If you want even more control or pacing, you could even take out a chunk once a week.

6. How to deal with purchases that go across multiple categories

Sometimes you’ll be at a store like Walmart or Target and want to make a purchase that covers multiple categories. For example, you might be buying groceries, home improvement items, and personal items all at once.

There are two main ways to deal with this situation. The first and cleanest option from an accounting perspective is to split the items apart and have the cashier do multiple transactions. I’ve done this many times and it takes hardly any extra time. The cashiers can do it easily and usually the people behind me in line don’t even notice.

The second option is to make one purchase and combine money from the appropriate category envelopes. This really only works well if you have a few items. If you have a lot of items you often don’t know how much to total will be for each category and therefore how much money to take from each category. The other disadvantage of this approach is that you might not have exact change in your categories. But for some scenarios this may work well.

The third option is to pay for everything from one category and then look at your receipt afterward, total the amounts spent in other categories and move that money to pay back the original category you spent from. I don’t prefer this method because it’s just too much work. But again, it may come in handy on occasion.

7. Get used to planning ahead.

By committing to use only cash, you have to plan ahead at times to ensure you have the cash you need with you when you need it. For example, I often keep most of my personal money at home and only take what I need when I leave the house. If I forget to take some with me or run out while I’m out and about, too bad. I have to wait to make that purchase.

8. Give both spouses cash for a category if needed.

For the most part Emily does the grocery shopping, but sometimes I’ll be out and Emily will call needing me to stop and get something. For these instances, it’s nice for me to have $20-40 of the grocery budget on hand. The rest Emily keeps. If I don’t end up needing to use it, I’ll give it back to her towards the end of the month or when she needs it.

9. Don’t be tempted to use accumulated funds improperly.

Some categories, like clothing, may accumulate significant amounts in them before they’re spent. Don’t be tempted to use those funds for something else unless you truly don’t need them. One way to prevent temptation is to leave those funds at home in a safe place rather than carrying them with you. That way you only spend the funds when you truly need them. It also decreases the likelihood they’ll get lost or stolen.

I live in a safe place and will sometimes leave the funds for these types of categories in my glove compartment. They’re convenient to get at when needed but not constantly visible to me. Out of site, out of mind.

10. Only carry what you need with you

I’ve already referred to leaving some of your cash at home or in the glove box. There’s really no use in carrying cash with you all the time if it’s from a category that you may only spend in once a month or less.
By keeping money at home, it also discourages impulse spending. You have to consciously take the money before you make the purchase.

11. You must trust and be honest.

Using cash, there is some room for dishonesty in moving money between categories or using money from another category for personal purchases. If you don’t have a trusting and honest relationship with your spouse, using cash may pose some problems. However, it’s ok to use incentives when using cash. For example, my wife and I agreed that if she underspent on groceries, she could use the remaining money to build up our food storage. It was a good incentive for her to cut coupons or save a little extra and we all got the extra bonus and security of food storage.

Do you use cash in your budget? What tips do you have?


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Benefits of a Cash Budget - Part 2

Written by Sam on April 29, 2010 – 11:54 am -

Be sure to check out part 1 about the benefits of a cash budget. In that article I explain how cash is the ultimate tool to help you control your spending and staying within your budget.

In part 2, I explain how budgeting will help save you time in the budgeting process.

How Cash Will Cut Your Budgeting Time By 80%

Think for a second about entering transactions into financial software like Quicken or YNAB. What are most of the transactions? By far the majority of the transactions come from categories like groceries, household, or entertainment. They are purchases at the grocery store, or walmart, or the corner convenience store. What if you took those transactions away. For most people, there are only a handful or two of transactions left that occur every month. You might have utilities, a cell phone bill, a few gas transactions, but that’s about it.

Most of Your Transactions Come From Just a Few Categories

This is a classic 80/20 example. 80% of your transactions come from 20% of your budget categories. In fact, I would guess that for many people it’s more of a 90/10 rule. 90% of their transactions come from 10% of the categories. If you’ve used financial software in the past, go check this out and see if it holds true. In fact, leave a comment and let me know if it’s true. I know for us it IS true.

Now I want you to think about the time you spend budgeting every month and what that time is spent on. If you’re like us it’s spent on entering and/or categorizing transactions from the previous month. It’s spent tracking down transaction #x and finding out what it was for. Either you don’t remember or your spouse spent it and he/she doesn’t remember. You spend time tracking down missing receipts. It’s all a big mess.

Well all of that craziness doesn’t have to be. In fact, I’m going to give you permission to stop entering every transaction. How can I do that? Well let me ask this: why do you need to enter all those transactions? Do you really want to know how much you spend on milk every month? Do you ever really care to know on an itemized basis what individual items you purchased in your grocery category? I don’t think that’s the case. If you think about it, all you really care about is spending the amount you want to spend in any given category. Well I’ve just shown that you can accomplish this goal by using cash. You don’t accomplish this goal by tracking every little thing, if fact, doing so is a lag measure and won’t have any impact on how much you spend next month. You’ll just go through the same process taking a lot of time and experiencing the same or similar results.

One Entry To Rule Them All

So am I saying that we don’t enter in our grocery transactions? That’s exactly what I’m saying. We have one entry in YNAB that is a cash withdraw for our grocery category. We don’t keep receipts, we don’t enter individual transactions. And do you know what? We have achieved our goal of staying within our budget more frequently and consistently than we ever did tracking everything.

To be more specific, we have one cash withdraw, or sometimes two over the course of the month that cover a number of cash categories. At the end of the month, we may have as little as 10 total transactions in our register for the month and most of these are for automated transactions that are easy to identify, categorize and reconcile. It has literally changed our budgeting lives.

My cousin is a great example of how using cash can decrease your time spent budgeting. She pulls out cash for all of her non-automated expenses. She doesn’t even split the money into categories. She has such a good sense of how much money they need in the month for the various categories that she can consistently stay within budget even without categories. At the end of the month, she has roughly 10 total transactions (if I’m remembering correctly) to deal with in reconciling her budget. Talk about quick and easy. Now I wouldn’t recommend lumping all your cash together at first, but as you get a better intuitive grasp on your spending over time, you can easily start combining your cash categories like she does.

The Myth of Tracking Everything

Now I can anticipate how many of you are responding right now. Your mind is rebelling against the idea that you don’t need to track every single transaction. It’s true the idea of tracking everything has been drilled into us by many financial gurus over time. In fact, I’m reading a book called Your Money or Your Life
that emphasizes the importance of tracking everything. While it’s a good book in general, I think the advice to track everything is misguided.

Let me ask, what’s so important about tracking everything? Isn’t the reason you want to track so that you can control your spending? Does tracking every transaction help? When I ask myself these questions it ultimately comes down to not overspending. As long as I’m achieving that goal, it doesn’t really matter if I have a record of every transaction.

I’ll admit there can be some benefit to detailed tracking. For example, you could do a detailed micro-level analysis of your spending. Doing so could produce some valuable, if not interesting results. It could even provide some useful insights that may help you change your behavior. For example, many people are shocked by how much they spend eating out if they don’t track that separate from their grocery category. However, doing this type of analysis usually won’t change your behavior and once you’ve found areas in which you’ve overspent, it’s too late to go back and change it. The damage is already done.

If you’re an analytical person and really want to do a detailed spending analysis, go ahead and do it, but limit it to one or two months and you should get all the value you need from it. In general, I don’t think this type of analysis is necessary and prefer a top down approach rather than a bottom up approach as I discussed in my 10 Secrets to Marketing Success Podcast in week 3.

If you’re really concerned about overspending in a particular area, rather than tracking everything in detail, make that area its own category and take out only the maximum amount of cash you’re willing to spend.

The Psychological Advantage of Cash

The biggest psychological advantage of using cash is that it helps restore your connection with money. But there was another, unanticipated advantage for me and Emily. For years Emily always felt frustrated because I was a spender and she was a saver. Actually, that’s not quite right. Emily wasn’t necessarily a saver, but she didn’t feel like she could spend money freely because she knew I was already spending plenty and therefore didn’t feel like she could spend much more. She always felt either guilt or anxiety when spending money. By using cash, it gave her permission to spend. She had a very tangible indicator telling her it was ok to spend what she needed or wanted.

For me it was useful because I could decide ahead of time what my limit was and then throughout the month could see and be aware of that limit.

Your Action Plan

To take advantage of using cash in your budget to decrease the time spent budgeting simply take out cash for those categories in which you overspend or have a lot of transactions. Then over the course of the month don’t worry about keeping receipts or recording the transactions in your financial software. At the end of the month you’ll only have a handful of transactions to deal with and reconcile and you’ll be done in a flash.

It’s changed my life and it can change yours.


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Benefits of a Cash Budget - Part 1

Written by Sam on April 28, 2010 – 11:17 am -

In this article series of articles, I have recorded somewhat of a manifesto for using cash in your budget. You can listen to the whole thing in my podcast for week 4 of my 12 Weeks to Fiscal Fitness program, Using Cash In Your Budget.

In week 3 I talked in considerable detail about how to create a budget that works. In week 4, I’m going to talk about a tip that has been crucial in helping my wife and I stay within our budget. It has also helped us decrease the total time we spend on budgeting from month to month.

That’s right, I’m talking about using cash in your budget.

If you’ve been following this program faithfully, you’re already using cash in your budget. In week 1 I challenged you to use cash for your groceries and to choose to other problematic categories to use cash in. Now, I’ll finally go into the reasons for using cash.

Using cash in your budget is a tough topic. People shy away from it and toss it aside as being too much of a hassle. I want to challenge you to put those beliefs aside for a moment and let me make a case for using cash.

The fact is, I know how you feel. Using cash in our budget was one of the things I fought against most. We started using cash as part of Financial Peace University. It was one of those concepts I was ready to ignore and tried to convince my wife that we shouldn’t use cash. But she wanted to give it a shot and since I’d agreed to follow the program, I reluctantly went along.

I’m glad I did.

It quickly became clear how powerful using cash in your budget is. I was quickly converted and became a big advocate for using cash. In fact, I now consider it a requisite for having an effective budget. REALLY! I don’t know a single family who considers themselves successful at budgeting that doesn’t use cash. On the flip side, I know plenty of people who struggle with their budget or struggle staying within their spending limits and are always trying to figure out why. Yet, they resist using cash. They just won’t give it a try. Or they give it a half-hearted try and quickly give up.

How We Saved $6,000 In One Year By Using Cash

So what was the result of using cash for me and Emily? Not only did we stay within our budget consistently for the first time in our marriage, but we actually spent $6,000 less the year we started using cash with no perceived decrease in lifestyle. It was mind boggling that we saved so much. We saved an average of about $500 a month. We spent less on groceries, ate out much less, and no longer made impulse credit card purchases to the tune of hundreds of dollars a month. But I never would have thought those seemingly little things would make such a big difference in our savings.

The Advantages Of Using Cash

There are several advantages of using cash in your budget, but there are mainly two that I want to emphasize.

First, using cash makes it easy to control your spending and to keep within your budget.

Second, using cash will cut as much as 80% of the time spent reconciling your budgeting at the end of the month. While I’ve already showed you how to speed up your budgeting process, using cash is the thing that will have the greatest single impact in decreasing your budgeting time. My wife and I spend 30-60 minutes a month budgeting. THAT’S IT!

In this article I’ll be addressing the first advantage of using cash.

Before I jump in let me point out that I’m not saying you need to use cash for your WHOLE budget. In fact, there are some cases in which using cash doesn’t make sense. You’ll mainly want to use cash in those categories in which you tend to overspend. This may only be 2 or 3 categories.

Controlling Spending With Cash

The Power of Instant Feedback

Cash is the perfect instant feedback mechanism. It easy to keep from overspending because when the cash is gone, you know you’re done spending. It’s really as simple as that.

Alternative Ways to Track Your Spending

When using credit cards you are totally disconnected with how much you’ve spend and how much is left to spend. Some people try to track their spending by writing everything down in a notebook, but in my own personal experience and hearing experiences of others it’s very difficult to be consistent with a system like that. Inevitably you stop keeping track.

Even using debit cards to keep track of spending doesn’t work because you’d have to constantly check your account balances. And when you do check your account balance you’ll just see a lump sum in your account and won’t know how much you have to spend in a particular category.

A third option of keeping track of how much you have left to spend would be to update your personal finance software. YNAB is particularly good at showing you how much you have left to spend. But again, this would require updating the software daily. It’s also prone to errors if you update it daily because you might miss purchases that haven’t posted to your account yet or purchases your spouse has made that you don’t know about. Not to mention it would take a lot of time and effort to keep things updated on a daily basis.

So after eliminate all those possibilities, cash stands as the ultimate way to control your spending.

Lead vs. Lag Measures

Let me explain in another way why cash works so well. There’s a concept I learned about while working at a former company called lead and lag measures. Please bear with me because this is a somewhat geeky concept, but it illustrates an important point.

Lead and lag measures are simply things we can keep track of to help change our behavior or reach goals. A simple example of a measure would be weighing yourself if your trying to lose weight.

The key here is that Lead measures are much more effective in helping us change behavior than lag measures.

Let me explain the difference between the two.

A lag measure shows what has happened in the past, whereas a lead measure is predictive as to what will happen in the future. Let’s use football as an example. A lag measure in football is the score. The score shows you what has happened previously in the game, but really doesn’t predict what will happen the rest of the game.

In contrast, a lead measure might be first downs. If you want to score, rather than simply focusing on scoring, you can focus on first downs. The more first downs you get, the higher your probability of scoring. Therefore the number of first downs are going to be at least somewhat predictive of the future score. Now obviously there’s not a 1 to 1 correlation between first downs and scoring, but there is a strong correlation nonetheless.

So instead of focusing on just the score, you can break down your goals into more accomplishable steps and measures that will help you reach your goal.

Now there’s one other type of measure called a quick lag. A quick lag looks like a lead measure, but really isn’t. The best example of a quick lag weighing yourself if you’re trying to lose weight. Many people try to use this as a type of lead measure. They use this as the primary measure for losing weight. It seems like a lead measure because you get instant feedback. However, if you think about it your weight is just showing you the results of what happened in the past. It gives you no indication of what you’ll weight tomorrow or next week or next month.

So what would be a true lead measure in this case? Well, the number of calories you eat every day would be a good lead measure. The number of calories you eat WILL be a predictor of how much you’ll weigh in the future. This also points out one more thing: good lead measures need to be controllable. Some lead measures may predict future performance, but are hard to control. Counting calories is a good lead measure because it is very controllable in addition to being highly predictive of future results.

So let’s bring this back to personal finances. Most people using their credit card or bank statements as a measure for controlling their spending.

Is looking at your statement a lead or lag measure?

It’s definitely a lag measure because it shows you what has already happened. Plus it has absolutely no bearing on what will happen next month. By the time you look at your statement it’s already too late. You’ve already over or under spent and there’s no going back. This is actually about the worst way you can try to control your spending yet it’s the method most people use.

In contrast, taking cash out to use for a budget category is like the ultimate lead measure. It’s a perfect predictor of how much you’ll spend in that category this month. Of course that’s assuming you and your spouse are truly committed to using exclusively cash for that category. If you take out $400 for groceries, you won’t be able to spend any more once the money is gone. There’s no more accidental overspending. Using cash may not perfectly predict the exact amount of money you’ll spend because you may underspend, but hey, that’s a good problem to have.

The bottom line is: Cash is a great instant-feedback mechanism that allows you to see instantly how much you have left to spend. This leads us to another reason why cash helps us control our spending.

Re-calibrating Your Relationship With Money

Cash renews or re-calibrates your connection with money. Let me explain. The use of credit and even debit cards has really disconnected people from their money. It’s easy to overspend and go into debt with credit cards because it’s like play money. You don’t actually see the money leave. It’s so abstracted that you don’t FEEL the money leaving.

Cash restores this connection. When you use cash you can see instantly at anytime how much you have left to spend. As you spend cash you see and feel it leaving. You see your wallet, or budget envelope, get smaller. There’s a critical emotional piece to having this physical, visceral experience. Cash becomes something tangible and real. You get to experience that there is an end to money when it runs out. This has a big impact on how you spend money, even if you don’t notice it at first.

As you start using cash, you’ll begin to develop a type of intuition regarding spending. When you go to the grocery store and look at your remaining cash for the month, you’ll start to get in tune with how much that will buy. If your wallet it thin, figuratively or literally, you’ll know that you need to buy only essentials; it may be bread and milk and not much else. In contrast, if your wallet is thick, you’ll know you can be more liberal in buying additional items. Either way, it definitely will INFLUENCE YOUR DECISIONS and that’s something that rarely if ever happens when using a credit or debit card.

The Big Question

There’s one last reason why using cash helps to control spending. It help you ask what I call the BIG QUESTION and that is “where is this money coming from?” When using cash, it becomes clear very quickly that you can’t be too squishy in your spending. In fact, you can’t be squishy at all. If you spend money it has to come from one of your categories and/or cash envelopes. Once we started using cash Emily and I found ourselves asking each other quite frequently “where is this money coming from?” If the expense comes from a well-defined category and we have money left for that category, the answer is self-evident. However, if we need more groceries, for example, and the cash is gone, we’d have to decide what other category we were going to take it out of.

This simple pause in the decision-making process is responsible for Emily and I saving $6,000 the first year we started using cash. By making our spending conscious we often changed our behavior not out of self-deprivation, but out of common sense.

For us, the big question seems to come up most often when eating out. Are we going to use “date night” money, “grocery” money, or “personal” money? The fact is, we will sometimes use money out of all those categories for eating out, but we still have to ask the question. Sometimes, if we’re really tight and all those categories are empty, or we need the money for something else, we’ll decide not to eat out.

Some people may view this as overly strict or restricting. But asking the big questions creates the exact decision we should be making when we spend money. Spending money is ALWAYS a trade-off decision. If you spend money on one thing you simply can’t spend it on another. Using cash just makes this decision explicit. While that can come as a harsh reality for some, it is reality nonetheless.

Now I’m not saying using cash has to force you to live a life of self-imposed restriction. If you have more money to budget to various categories and you choose that you value those categories over others, by all means increase your cash categories to the point where you almost always have money left over. I really don’t care how much you allocate. The main point is to simply live within your means and to reach your important financial goals.

But for those who are on a tight budget, using cash and learning to ask “where is this coming from” will become the key to surviving and eventually thriving.

Well, hopefully I’ve convinced most of you that using cash in your budget is worth a shot. In the next post I’ll talk about the second main advantage of using cash in your budget…decreasing your budgeting time.


Posted in 12 Weeks to Fiscal Fitness, Budgeting, Cash | 1 Comment »
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