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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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Posted in 12 Weeks to Fiscal Fitness, Budgeting, How to | No Comments »

How to Create a Financial Binder

Written by Sam on August 26, 2009 – 9:30 am -

financialbinder
It’s a common worry. Am I spending more than I should? When are my bills due? Have I paid them? Am I on track to reach my financial goals? Am I going to be able to get out (or stay out) of debt? Financial worries are not only one of the greatest causes of personal anxiety; they can also be one of the biggest strains on a relationship.

Many people don’t have their finances well organized and therefore aren’t able to tell where they stand. Disorganized finances can have severe consequences; In the short-term, you may end up paying hundreds of dollars in late fees and penalties. You may be digging yourself deeper into debt without even realizing it. In the long-term you won’t meet your high-level financial goals. Couples often end up re-hashing the same financial issues over and over again because they don’t have a way of tracking the decisions and progress they’ve made as a result of their arguments…er discussions. If your finances are not organized how can you ever have any hope of getting them under control?

The good news is that by taking one simple step you can start down the road of financial security and begin to get your finances in order. You can get a good overall view of your financial picture and establish a base from which you can build your financial future. It all starts with creating your financial binder.

What is a financial binder?

A financial binder is a place to keep all of your high-level financial information including important decisions and goals you’ve made. Instead of containing transaction-level, detailed information about your finances, it is a place for summary-level information about such things as bank accounts, bills, financial decisions, savings goals, taxes, and credit reports.

Your financial binder doesn’t necessarily have to be a binder. Any form of organizing papers into categories could technically work. However, there are certain advantages to using a binder.

  1. Binders are easy to expand. You can always add more tabs or upgrade to a larger binder (up to 5 inches).
  2. Binders are easy to customize. You will inevitably want to create categories and information unique to your situation.
  3. A Binder keeps items in one place and prevents them from getting misplaced.
  4. Binders are portable. My wife and I sometimes like to review our financial progress during quarterly getaways. Being able to take our binder and go makes it easy to conduct these remote reviews.

Paper vs. Digital systems

Many people ask why they shouldn’t keep their binder information in digital form. Although your binder is paper based, many of the contents may be created digitally. Simply take the last step of printing out the documents after you work on them and you’ll have a nice backup. Whenever you print a document, be sure to record both the date printed and the digital location of the file for later reference. While digital files do have advantages I discourage the use of exclusively digital storage for the following reasons.

  1. The “did I change this?” factor. By printing out a hard copy of digital files, you put a stake in the ground so to speak. You establish that “on this date, I made this decision” rather than second guessing if you’re looking at the most recent version of a document.
  2. Backup. If you haven’t had a hard drive crash on you yet, it’s just a matter of time. Most people don’t have adequate digital backup plans.

Here’s a handy tip: To make it easy to cross-reference your paper and digital files, alter your Microsoft Word or Excel settings to automatically print the date-printed and the digital location of each file. In either program, from the menu select “View — Header and Footer.” You can then configure exactly what you want to appear at the top and bottom of the page. You may have to play with this a little to get exactly the effect you want.

What should a financial binder contain?

Net Worth Statement

Ok, let’s get the big one out of the way first. Even though your net worth statement will probably only be less than a page long, it needs the most explanation. A net worth statement is the best way to track your overall financial progress in one quick view. It simply shows all of your assets minus all of your liabilities. If you’ve never created a net worth statement, don’t make it too complicated at first. Start with just the basics at first and you can make it more detailed over time.

Step 1.

List all of your assets, one per line, along with the value for each. For your first version, just list your bank accounts, investment accounts, and a rough estimation of how much your house is worth. If you have no idea how much your house is worth, just put down the amount you paid. Every time you update your statement, make an improvement – add the value of your cars, refine the calculation of the value of your home based on other houses for sale in your neighborhood, or start adding possessions that have significant value such as jewelry or electronics. Adding your possessions provides a nice side effect – it can act as a record for home owners insurance if items are damaged or stolen.

You can use online services to refine the value of your assets. Use Yahoo! Auto (auto.yahoo.com) to estimate the value of your vehicles. Zillow.com will give you an estimated value of your house (accuracy can vary wildly so you may need to do a gut check) or you can use RealEstate.com to find the asking price for similar homes in your area. Search for possessions on eBay.com to see what the market price is for similar used items.

Once your list of assets is complete, sum the individual amounts to show your total assets.

Step 2.

Next calculate your liabilities. For most people this will simply be a list of your debts. List each liability – each loan, for example – and the amount on a separate line. Sum your total liabilities.

Step 3.

Now subtract your total liabilities from your total assets and, voila, you have your net worth! The higher the number the better. Hopefully it’s not negative. This is a valuable report to keep because you can see your progress over time. Sometimes it’s hard to feel like you’re making progress, even if you’re saving or paying down debt aggressively. Your net worth statement shows the concrete effects of your efforts.

You should update your net worth statement at least once every quarter (three months) but if you’re financial situation is in a state of flux, update it monthly.

Monthly Budgets

Every time my wife and I discuss and finalize our budget each month, we print it out, sign it, and file it in our financial binder. This may sound a little strange but it’s amazing how this helps us avoid arguments in the future. It’s too easy otherwise to second guess if this was really the budget we’d talked about. Having a list of previous budgets easily on hand makes it much easier to plan for future months or compare if expenses have gone up or down over time.

A list of bank and investment accounts (including passwords)

Keeping an updated list of all your accounts is a great reference tool. I’m always amazed how easily people forget that they have open accounts they forgot about. This list will help keep your accounts up to date. It’s also a great place to list your usernames and passwords for each account.

A List of your bills

This list is one of the most important. It will help you to pay your bills on time and make sure there’s enough money in the respective accounts to pay your bills. Specifically, you’ll want to track:

  • The name of the company the bill is from.
  • When each bill is due. Be sure to list if the bill is due on the same day of each month (the 15th of each month) vs. every x weeks (every 4 weeks).
  • The amount due for each bill. If the amount varies from month to month, list the range – the maximum and minimum you’ve had to pay in the past.
  • How each bill is paid. Do you pay with cash, check, credit card, or using a direct bank transfer? If you pay the bill with a check or bank transfer, list the bank it’s paid from.
  • Usernames and Passwords for each account (if applicable).

A list of decisions you (and your spouse) make about finances

This is where most of the customization will take place. List anything you think is important. Whenever you have a financial discussion with your spouse, take a couple of extra minutes and write down what you talked about or decided. This will keep you from having the exact same conversation over again. Writing it down doesn’t mean you can’t change your opinion, but will simply act as a starting point for future discussions.

Short, medium, and long-term savings goals

These should be three separate sections. These may take the form of simple lists or more involved calculations (e.g. planning vacation expenses). We often keep lists of our savings goals in excel spreadsheets and then print them out for the binder. This allows us to easily make changes and calculations as we alter the lists.

Short term goals would be things like household purchases typically under $300 or things that might take a few months to save for. Our list of short-term savings goals is the longest of the three and includes just about everything we want. It’s really our wish list of household purchases. When we have a little extra discretionary income, we’ll typically refer to this list to determine what to buy. This list also changes the most of the three. We commonly add and subtract items.

Medium term goals are items over $300 including things like vacations or items that take less than 5 years to save for. We also include in our medium-term list things like furniture and gift giving. In fact, we break down all the people we want to give to throughout the year and how much we want to spend so we can ensure we have the money budgeted when it’s needed. We do the same for vacations, breaking each vacation down into travel expenses, lodging, food, etc, so we know how much to budget. We typically refer to this list when we have a windfall such as a larger tax return or bonus.

Long-term goals are things that take over 5 years to save for including things like retirement and college savings.

Summarized Insurance information

If your insurance companies provide you with summaries of your coverage, use those. If not, try to summarize on your own how much coverage you have in each area. Include all types of insurance including health, disability, dental, life, auto, and home-owners.

This may be one of the toughest sections to flesh out. I must admit it’s where my financial binder is most lacking. If you’re not sure how much coverage or what type of coverage you should have, a certified financial planner should be able to help.

Summarized tax information

If your tax preparation software or accountant provided you with a summary of your tax return, keep it here. You could keep your entire return here if it’s not too large.

Credit Reports

Keep the most recent version of your credit report from each of the three major agencies: TransUnion, Equifax, and Experian. By law you are entitled to one free report a year from each company. To get your free reports, visit www.annualcreditreport.com.

Keep it safe

Your financial binder is such a great tool to help you get your finances under control, but it also can pose a risk. Having all your summary financial information in one place can make it easy for snooping eyes to see things they shouldn’t. Keep your financial binder in a safe place – a locked drawer or, even better, a fireproof safe.

Take One Step TODAY!

Getting started organizing your finances isn’t hard. It just takes consistent effort over time. Don’t try and enter all this information at once. Do one thing a week…or even one thing a month. The most important thing is to get started TODAY! Take one simple action – if you don’t have a binder, tabs, or a labeler, go buy them. If you already have the materials, put in the information that’s readily available to get started. Every time your review your finances, add one more thing. You’ll often find that taking the first step is the hardest, then you’ll be naturally compelled to take more as you start to get financial clarity. Get started today down the road to financial control.

This article was originally written for Organize Magazine. A shortened version of this article previously appeared in Organize Magazine.


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Posted in Finances, How to, Organization | 5 Comments »

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