A few weeks ago, I got into a little bit of trouble with my article on Why You Don’t Need to Do a Budget. (I’ve since changed the name, and rewrote several parts to try to make my point a little clearer.) Several hardcore budgeters reached out and said something along the lines of “well, that may work for you, but budgeting is crucial for me. In fact, it’s why my family was able to get out of debt!”
So, I want to clarify the point I was trying to make in that post and admit that perhaps I tried to be a little too “controversial” with that title. (As much as I hate clickbait myself, as a writer it’s tempting to “push the boundaries” a little to entice someone to read your work. Well, in hindsight, maybe I went a little too far.)
Anyway, now that I’ve issued my “mea culpa,” let’s move on and take a look at something that I do really think is helpful to get a handle on your finances. Is it more important than a budget? Probably not, but it’s a really good place to start, because it summarizes the important information all on one page, and it’s a really easy win. On top of all that, it takes very little time to do!
Focus on the Big Picture
Again, I was not trying to say that people shouldn’t ever do a budget. Budgeting is a very useful habit; however, I do think (and have seen) that a lot of people get overwhelmed when they try to start budgeting. They sit down to “crunch the numbers” and soon get lost in all the details. So instead, I recommend starting with the important things first: a big picture viewpoint of what is happening with your money.
Once you have a big picture viewpoint, you can pinpoint the areas that you would like to change, such as getting out of debt or saving more for retirement, and budgeting is a good way to help you do that (although personally I still prefer the anti-budget approach.)
To take that first step you will create a simple spreadsheet called an Annual Cash-flow Summary. Think of it like this — if you’re building a house, you’ll need both a blueprint and a tape measure. An annual cash-flow summary is like the blueprint, and your budget is like the tape measure. A blueprint gives you the big picture of your project — the overall layout of the house, the dimensions of the rooms, and how many windows you will need. And the tape measure will help you actually cut the boards to the correct lengths. Both are necessary, but you’ll want to get the blueprint done first. You can buy the tape measure when you’re actually ready to start cutting something.
Ok, enough of my poorly designed analogies. Here’s how to do one of these Cash-flow Summaries:
How to Do an Annual Cash-flow Summary
In the video below, I walk you through exactly how I do an ACS for clients. It’s a pretty simple spreadsheet of about 10-15 lines of information. I start with gross income (not what hits your bank account, but what you actually get paid), and subtract out any savings and taxes. What is left over is what you spend on “living expenses” of one sort or another.
How to Use an Annual Cash-flow Summary
There are so many practical applications for an ACS. Here are just a few:
- What is my monthly nut (aka, the amount I spend, on average, for living expenses)? As much as you might want to bury your head in the sand on this, it’s really helpful to know this number. Why? Because if you ever want to retire someday, knowing how much your investments need to produce to cover your expenses is, well, obviously kind of important.
- How much am I saving towards retirement? Most people should probably shoot for at least 10-15% of their gross income.
- How much am I paying in taxes? In the video, I just focus on the taxes that are actually withheld from your paycheck. (Because YouTube only gives me 15 minutes, I had to cut some detail out of this section.) However, if you’re getting a big refund every year, you might want to subtract that from the amount you withheld. The bottom line is that if your net Federal income tax (not including Social Security/Medicare) is more than about 15% of your gross income, and you don’t make 6-figures or more, you might want to talk to a professional.
- Social Security and Medicare taxes go away in Retirement — The taxes you pay for Social Security and Medicare go away in retirement, so I subtract them here. You could look at these as a form of “savings,” because your taxes go towards the Social Security and Medicare retirement benefits.
- Should I include my mortgage in my living expenses? If you watch the video, you’ll notice that I do not take your mortgage payment out, so it is included in the living expense number at the bottom. The reason for this is, contrary to what many (most?) articles will tell you, your mortgage will probably not be paid off when you retire, and that is ok! I’ll have to write a whole post on this, but for several reasons, the primary of which is due to mortgage interest rates being so low, it usually makes more sense to leave money invested than to pay off your mortgage.
I hope this has been helpful. Next I plan to do a video on how to do a Net Worth Statement using a simple Google Sheets spreadsheet. Along with the Annual Cash-flow Summary, the Net Worth Statement gives you a complete big picture view of your finances so you can dominate them!
I definitely recommend this as an annual habit. Do this every January to kick off your year right.