|Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.|
How to Manage Your Personal Finances like a Business
What we know about successful companies is that they manage their cash flow based on allocation – they allocate their cash to various accounts so it can be managed according to different objectives. Generally, a company will have a cash-on-hand account to cover immediate cash needs; a working capital account to cover ongoing operating expenses; and a long-term account to save for future capital investments. Each account is managed separately according to specific guidelines established through a budget, so financial decisions are almost all automatic. The only way anything changes, is by restructuring the budget which might be done as part of the company’s annual planning.
Now imagine yourself as a company. What would be the benefit of structuring your personal budget around three different accounts, each with specific guidelines for their use? Too complicated? If you think about it, you’re already doing it, except you’re trying to manage all three in your head, which is why most people suffer from muddled brains when trying to make basic financial decisions.
The goal is to simplify; and the best way to do that is by breaking your budget down into smaller, more manageable pieces. And, if you think about these pieces as “compartments” or “buckets,” it becomes easier to manage them according to their objective or purpose. Your spending objectives will be more clearly defined, and, by having separate guidelines for each account, your financial decisions are practically made for you.
Here’s how you can manage your cash flow like a business:
Daily Spending Account (Cash-on-Hand Account)
Your daily spending account is a bank checking account used to pay your budgeted expenses. You deposit the amount you need each month to cover your daily expenses, your bills, and other life style needs. If you budget effectively, this account should nearly zero out at the end of the month. If you manage to live below your means, any excess cash can be transferred to your Savings or Emergency accounts.
Emergency Fund (Working Capital Account)
Before starting a long-term savings or investment plan, it’s vitally important to establish a fully liquid, completely safe emergency fund which houses your cash reserves equal to 6 to 12 month’s worth of living expenses. As part of your initial budgeting, you should budget for a minimum savings amount that should be deposited in an interest checking, savings or money market account at the same time you deposit funds in your daily spending account. Once you achieve your goal for funding your emergency fund, you can then allocate your monthly savings towards your savings account.
Savings Account (Capital Account)
Your savings account is an interest checking, savings or money market account that houses the funds you’ve earmarked for savings or investment towards your financial goals. The amount that goes in this account is established as a monthly savings goal, separate from your automatic contributions to your qualified retirement plan, which should be deposited at the same time you make a deposit into your daily spending account. Once you’ve established a systematic investment program, these funds can be transferred or deposited directly into your investment account.
Finally, you need an Exit Plan account. As a business owner, you need an exit strategy that enables you to leave your business on your terms with the best possible outcome for you and your family. However, because business exits don’t always go as well as planned or hoped for, you need to fund an exit plan account, which is, essentially, your retirement plan. Business owners who wait too long to begin funding their retirement plan are often forced to change their exit plans, which might involve working in their business much longer than they intended.