To know your financial health, make like a weatherman and forecast
Imagine if you showed up to the doctor and sat down to look at charts that he or she forecast a few years into the future. “Your blood pressure is set to spike to a new plateau in November, your BMI is reaching dangerous levels come December, and your cardiovascular health will begin to deteriorate symptomatically by next Spring.”
You might be spurred to take action and prevent those drastic outcomes!
What if, instead, you could make those kinds of declarations about your money? “You’ll be cashflow negative after Christmas spending, might want to dial that back a bit. Your debt will begin accruing interest and requiring payments next Spring, better set aside some cushion for when those bills hit. That $100 check from Grandma at Christmas might just save your butt when it’s time to buy books for the Spring semester; don’t blow it on beer.”
Unlike the imaginary doctor’s office, you can find out the state of your financial health – now and in the future – from the comfort of your couch. The key is to forecast, not budget, your finances.
What’s the difference between budgeting and forecasting your finances?
For budgeting, the typical approach is to set limits on spending categories each month and then try to stay under those limits. Forecasting your finances means putting all your expected income and all your expected expenses on a timeline.
The former approach is banal, torturous, and quite possibly the opposite of rewarding. Finances can feel like a monthly self-flagellation sesh when you’re budgeting.
If you switch from budgeting to forecasting and learn time/money manipulation, your “doing my finances” chair morphs from a dentist’s recliner to a captain’s seat as you navigate your 747 (or Cessna, shh bby is ok) through turbulence. Just a couple button clicks here, a little Excel Ninja there, and voila – no more thunderstorm on the horizon.
Before you forecast, create a simple setup
Whether your finances are bare-bones simple or extraordinarily complex, you can benefit from setting up a single depository account. Basically, run EVERYTHING through one checking account. All student loan disbursements, computer lab income, refund from the $40 copay that you didn’t owe after all, the credit card bill from your car’s catalytic converter failing right before a road trip – EVERYTHING should go through one account.
You can have accounts outside of this single checking login, obviously. They key is that money flows THROUGH this one account to the others.
Setting up just one account as Primary allows you to answer questions like, “What is my low balance in the next 12 months?” Whereas that would be difficult to answer if your money is flowing around multiple accounts, you can write a simple Excel formula to answer that and many other inquiries.
You can’t change the weather, but you can change your financial forecast
My father-in-law, a local TV weather watcher, always said the weather was “Fine for those who like it. Lousy for those who don’t.” When it comes to money, you can learn techniques to make every month Fine and no month Lousy by moving money around in time.
Imagine if you could mix around the weather forecast just a bit. With some practice, all the rain, snow, and ice would occur between Monday and Thursday. All the sunshine would beam down on Friday, Saturday, and Sunday!
As you gain experience and learn techniques, you can actually move around the “weather” in your finances. If a big expense – say plane tickets – would put you in the red in July, then you can put plane tickets a credit card with a 30-day grace period and delay the expense until the extra August paycheck is delivered to save the day.
There is no better way to learn about “the time value of money” than seeing a big RED checking balance turn yellow because you managed to delay a major expense or accelerate some income.
What does a personal financial forecast look like?
Five columns: description, date, transaction amount, running total, and status (all statuses are empty in this example, because it’s in the future).
Using this template is relatively simple. The running total is the only “tricky” part of using this template in Excel. For example, if you move a row from 2377 to 2370, you’ll have to copy/paste or fill from D2369 downward to correct there references. When a transaction is Posted, the status column needs to be updated to “Posted.” When you get the hang of those two simple tasks, you’ll be moving thousands of dollars around your timeline in a hurry.
This template features a “savings” built into your primary account, i.e. what I call my pad. I usually have some $1000 for housing expenses, $500 for car expenses, and $750 for vet expenses give-or-take. And I want it available in my primary checking. So I “allocate” those balances on a second tab, and the formula that calculates my “low balance” automatically deducts the savings allocations.
Oh, and color code to you heart’s desire! I like my forecast to be colorful.
Trusting your prognostications
Think of a typical 10-day forecast. For days 1 and 2, you trust the prediction enough to start planning outfits. Days 3-5, you discount the accuracy a little bit, but they give you a general idea of the upcoming weekend. And for days 5-10, you don’t fully trust them, but it’s a lot better than just flipping a coin and thinking, “Well, I hope our outdoor wedding doesn’t get rained out!” You can start planning your response to an undesirable forecast.
Forecasts are especially helpful when you’re traveling. When you’re running through your checklist (you did keep a checklist from the last time you traveled, right?) and you get to the raincoat: what’s the first order of action? Check the forecast! No rain in sight, no raincoat. Easy peasy.
What if you arrive at your destination, and a squall is added to the forecast. Oh no! Well, at least you were checking the forecast and have time to grab a poncho before the deluge hits.
Think of a Cashflow Forecast as the same as a 10-day weather forecast, but in increments of months instead of days. The next month will be very accurate. Twelve months from now will vary quite a bit from your prediction.
Change the weather! Cashflow manipulation strategies
I’ve seen several articles in the personal finance blogosphere that recommend delaying purchases. A guru might suggest to put a 30 day wait period on any moderately sized expenditure. This has wonderful psychological effects, for example, I’ll often forget I even wanted an item to begin with!
Delaying is also extraordinarily powerful to buy you time: time until your bonus is delivered, time until you hit one of those awesome 3-paycheck-months, time until your tax refund is deposited. And if your forecast is accurate, you can easily tell when you’ll need to buy yourself time the most.
The beauty of knowing that you have a crunch coming in a couple months is that it’s in a couple months! Given that amount of time, you can take action early to pad your account in anticipation of the lean times.
Raising cash can take the form of Craigslist/eBay/Facebook sales, moonlighting, freelancing, credit card signup bonuses, taking on debt, etc — There’s thousands of ways to help with a shortfall. The key is to know the shortfall is coming well in advance, by forecasting your cashflow.
Check out our posts on Building Wealth to learn more about how to accelerate income.
Apply payment terms (like NET30) to your personal finances
When you’re dealing with money on a timeline, payment terms are a critical element to success. Some terms are fixed, some come laden with penalties, others are completely undefined, and still others are fudgeable but only if you ask.
Corporations use terms like “NET30” to record when they expect to receive payment from a customer. That particular term means “Pay me in full within 30 days.” Essentially, payment terms are short term credit lines. Generally, better customers will earn better terms while newer customers or those with a bad history will receive worse terms.
Some corporates are so infamous for their handling of payment terms that they’ve gained notoriety. I’ve read before that Walmart will often sell 100% of a product before they even have to pay for it! How do they do that? In six characters: NET120 – by being great customers, ordering in large volume, and always delivering payment on time, Walmart is rewarded with the best payment terms. What’s it gain them? The ability to sell other companies’ products, bank the income and earn interest from it, and clear their Accounts Payable without ever putting a dime of their own money to work.
You, too, can arrange payment terms to benefit you. Hardly anyone expects to hand you a $2,000 bill and say, “Pay me now.” If you’re an animal lover, you’ve likely seen a large veterinarian bill or two. At the bottom of the bill are usually terms. For example, my vet gives a 3% discount for cash or check within 7 days. They’ll also extend credit for 0% up to 6 months for bills over $500. That last bit isn’t listed on the bill! I had to ask.
I’ve found that doctors, contractors, lawyers, and other service-oriented professions will often extend the best terms to small clients. Credit card issuers will often waive late fees or extend short term low interest rates if you’re in a pinch. On the other hand – banks don’t play that. Don’t ever expect a bank to give up a payment term negotiation without getting cold, hard cash in return. That’s their lifeblood. A landlord might fall into one category or another, just don’t abuse their goodwill if they’re gracious enough to extend it!
Unexpected sunshine in your cashflow
If you use the forecasting method for some time, you’ll find that life sometimes gifts you blue skies instead of a thunderstorm.
I once wrote a landlord, “Thanks to a few happy money surprises, we’re terminating the lease to buy a house!” She wrote back that she could use a few happy money surprises of her own – which I’m sure my email was not.
Because I have my money forecasted out to two years in the future, I can tell right away if I need that $40 from a Craigslist sale to cover an upcoming shortfall, or if I can immediately transfer it to a retirement account. When low pressure fronts are on the horizon, I try to manufacture sunshine by raising cash!
Measure your financial health for tomorrow, today
Take some time to see what your finances look like over the next year or two. You’ll have a much better appreciation for the challenges you need to overcome and the flush days you’ll be able to enjoy. Put all your expenses and all your income on a timeline, find the lows and the highs, and start moving money around in time. It’s much easier to dress for the weather if you have an idea of what the weather will be. And may you have many days of unexpected sunshine!