Dev is earning a monthly salary of Rs. 75,000 and has expenses including home loan EMI, car EMI, groceries, utilities, and credit card bills that total to Rs. 50,000. He also likes to indulge in luxuries like dining out and going on vacations that cost him Rs. 25,000. He believes that he has a surplus of Rs. 25,000 every month and starts spending more on luxuries. However, he does not keep track of his expenses closely and ends up overspending on credit cards without realising it.
As a result, by the end of the month, he finds himself with a negative cash flow of Rs. 20,000 and has to borrow money from family and friends to make ends meet. This starts a vicious cycle of overspending and borrowing, leaving Dev with mounting credit card debt and a depleted savings account.
Many people struggle to make ends meet even after earning high income because of poor cash flow management. We will discuss the importance that cash flow management and budgeting play in personal finance in this article.
Importance of cash flow management:
Cash flow management is considered the foundation of financial management, and it is particularly crucial for individuals as it involves balancing income and expenses to create a surplus for investment and long-term financial independence. It is important to maintain a balance between the timing and amount of income and the timing and amount of expenses to avoid financial imbalance.
Cash flow timing is important because expenses must be covered by income as they occur. An example of this balance is a salaried person who receives a monthly salary and has monthly expenses such as grocery bills, utility bills and househelp salary, etc. A mismatch in cash flow can lead to the need for debt, which can be costly. When income is received at irregular intervals but expenses are consistent, this can result in a short-term cash flow shortage that must be met through debt, which incurs additional costs in the form of interest and reduces savings.
To ensure financial stability, there must be enough income to generate savings. This savings is crucial to have as a reserve for unexpected expenses or difficult times. Poor cash flow management can cause stress and tension for the individual and their family, affecting their overall well-being and peace of mind.
Proper cash flow management allows for control over finances for both families and individuals. It gives a sense of empowerment as it provides confidence that finances are being managed correctly. It also allows for smooth operation of household expenses as funds are readily available when needed.
Budgeting
Budgeting is an important aspect of personal finance management as it helps individuals and households to plan and manage their income and expenses effectively.
To create a household budget, one should begin by listing out all sources of income, including both regular and irregular sources. This includes income from regular sources such as salary and rental income, as well as income from less frequent sources like investments. This will form the basis for the budget and help to determine the overall income for the household. The expenses can be categorised in three categories: mandatory expenses, essential living expenses, and discretionary expenses. Mandatory expenses are those that must be paid, such as taxes, rent or mortgage payments, while essential living expenses are necessary for daily life, such as groceries and transportation. Discretionary expenses are those that can be cut or reduced if needed, such as entertainment or dining out.
The savings of a household are determined by subtracting total expenses from total income. If a household is spending more money than its income it would be operating at a deficit and would have to cut back on expenses.
Cash management
Managing cash flow is a crucial aspect of household budgeting. While the budget may show a surplus or savings on paper, it is important to ensure that this corresponds to the actual amount of cash available, as the income and expenses must be supported by real cash.
For example, if Ajay earns Rs 30,000 a month, it is important to not only consider this income when budgeting, but also to verify that the full amount is received each month. This is because Ajay's salary may include reimbursements, such as Rs 10,000, that need to be claimed. If these reimbursements are not claimed in a particular month, the actual cash inflow would be reduced to Rs 20,000. This can negatively impact the budget and potentially lead to a cash shortage.
Having too many expenses at the start of the month can result in a low overall cash balance, leaving less money available for spending later in the month. Additionally, unexpected expenses can cause a cash mismatch. Furthermore, if income is delayed, even for a short period, it can create a problem when too many expenses occur in the first few days of the month. Therefore, it is crucial to take all these factors and possibilities into consideration and ensure that there is enough cash available for various expenses, and have a plan in place to mitigate any delays or disruptions that may lead to a financial crisis.
To effectively manage cash flow, it is important to maintain a surplus in the bank or in cash to ensure that there is enough money available to cover unexpected expenses. Another strategy is to set aside a separate fund specifically for this purpose, which is distinct from an emergency fund used to handle disruptions in income. Effective cash management is essential for a successful budget, as it helps to avoid financial crises caused by a lack of funds to meet expenses. To achieve this, it is necessary to have a clear understanding of the nature of income and expenses in order to establish the appropriate cash handling position.
Income and expense statement
An income and expense statement provides a comprehensive view of an individual or household's financial flows over a specific period of time, whether it be a year or a month. It displays the actual amount of income earned during the period, as well as the actual amount of expenses incurred. This is a valuable tool as it allows for comparison between the actual figures and the amounts budgeted. It helps in keeping a check on the actual inflows and outflows, and making sure they are in line with the budgeted figures.
An income and expenditure statement also reveals the level of surplus or savings generated, providing insight into where money is being spent and what areas may require better management. It helps in identifying the areas where the expenses are more than the budgeted figures, and if there are any specific areas where more control is needed.
Keeping track of budgets and making provision for savings
As discussed earlier, budgeting is an important part of the whole exercise of financial planning for an individual or a household. Further, monitoring a budget is also an essential part of financial planning for an individual or household. It involves regularly tracking and reviewing actual income and expenses to ensure that spending stays within the limits set in the budget. Comparing actual figures to the budget plan can provide insight into the effectiveness of the budgeting process. Variations between budgeted and actual figures can reveal the strengths and weaknesses of the budget and aid in decision-making. Budget monitoring is an important step that helps to ensure that the budget is working as intended and make necessary adjustments.
Monitoring a budget requires consistent attention and regular review. If a difference is identified between the budgeted figures and the actual figures, corrective action must be taken. This may include adjusting the budget figures for the future, if there is an ongoing mismatch. For example, if the budgeted amount for transportation is consistently exceeded, it may be necessary to adjust the budgeted amount or consider alternative modes of transportation to reduce costs. Monitoring a budget allows for the identification of areas that require improvement, and therefore leads to an overall improvement in budgeting over time.
The ultimate goal of budgeting is to have a surplus of funds at the end of the budget period, which can then be allocated towards savings or other financial goals. This surplus is only achievable when income exceeds expenses, and it is a necessary requirement for making progress in other areas of financial planning.
Adequacy of savings
The savings generated from the budgeting process need to be evaluated in relation to the financial goals and needs of the individual or household. If the savings are not sufficient to meet the desired investment level for the future, additional steps may need to be taken to increase the savings amount through adjustments to the budget.
To bridge the gap between desired and actual savings, a step-by-step approach can be taken. One strategy could be setting a target to increase the savings rate by a certain percentage, such as 10%. Once this goal is achieved, a new target can be set to continue raising the savings rate. Additionally, cutting down on wasteful expenses and discretionary spending, directing large lump sum receipts towards savings, and reserving any increases in income specifically for savings can also boost overall savings.
In conclusion, cash flow management and budgeting play a crucial role in personal finance. Cash flow management is the process of managing the inflow and outflow of money to ensure that there is enough money available to meet the financial obligations. Budgeting, on the other hand, is the process of creating a plan for spending and saving money. Together, cash flow management and budgeting allow individuals to better control their finances, identify areas of improvement, and make more informed financial decisions.
Proper cash flow management can help individuals avoid falling into debt, miss important payments, or be unable to afford unexpected expenses. By monitoring and managing cash flow, individuals can ensure that they have enough money to meet their financial obligations and achieve their financial goals. Budgeting, on the other hand, can help individuals better understand their spending habits and identify areas where they can cut back or save more.
Effective budgeting and cash flow management can also help individuals achieve their long-term financial goals such as saving for retirement, buying a house, or starting a business. By setting financial goals and creating a plan to achieve them, individuals can take control of their financial future and secure a more stable financial position.
In short, cash flow management and budgeting are essential tools for individuals to better understand and manage their finances. By regularly monitoring their cash flow and creating a budget, individuals can make more informed financial decisions, achieve their financial goals, and secure a more stable financial future.
Комментарии