Part 2:
Budgeting: Cash Management

Financial planning should always start with cash management. As the initial building block of your overall financial plan, cash management addresses two major issues: finding the funds necessary to fund your plan, and ensuring that your cash is used to meet your goals. Think of cash management as a valuable yet, often overlooked, opportunity to put your money to work for you.

Even the least capable among us has some type of cash management system. Methods can range from "If the money is in my checking account, I'll buy it," to a detailed and organized plan to make the most efficient use of discretionary cash. An organized approach projects net cash flow to identify your current spending level and earmarks the funds available for investment.

Before you begin any aspect of financial planning, establish goals. Goal setting is the essential starting point of any sound financial plan — it gives a sense of purpose and direction.

Goals in each critical area of a financial plan may overlap because the areas of a plan often interrelate. For example, retirement planning also involves investment planning and cash management. Cash management goals are the starting points that work toward the attainment of broader, long-term financial goals.

Cash management goals should be realistic and attainable — not "pie in the sky" wishes — and should specify how to find the cash necessary to fund your goals. They must also be specific: How much will you save to achieve a particular goal (for example, by reducing entertainment and recreation expenses by $75 per month)? And how will you ensure that you save before you spend (for example, by taking advantage of an employer's tax-qualified plan)?

Define your goals and then list them in order of importance to you. If you have limited resources, prioritization helps ensure that the most important goals are met first.

Cash management goals depend upon several key demographic statistics:

• Age
• Knowledge of financial planning
• Time available to devote to planning
• Willingness to devote time to planning
• Marital status
• Dependent status
• Current financial status
• Current level and sources of income
• Future income prospects
• Ability to deal with risk
• Personal health

Examples of cash management goals:

• Eliminate installment and revolving debt
• Reduce current income taxes
• Eliminate bank service charges
• Make all retirement contributions by payroll reductions, if available
• Use an average annual payment system for utility bills
• Reduce discretionary spending for entertainment and recreation to $175 each month
• Refinance home mortgage to lower the interest rate and monthly payment
• Contribute $200 monthly to a children's education fund by an automatic bank draft

Generally, families live by one of three cash management plans:

• The "Feel Good" approach — Little or no consideration is given to future needs. Living only for today by spending all available funds.
• The "Out of Sight/Out of Mind" approach — Some thought is given to the future by putting funds aside upon receipt, but are dipped into, as necessary.
• The "Organized" approach — A specific plan is developed based upon historical spending to make the most efficient use of all funds.

Rationalizations people use for not developing a cash management plan include not enough assets to justify a cash management plan, the belief that finances are already in order, procrastination and refusal to contemplate the future.

Failure to develop an organized approach to cash management could lead to such avoidable financial problems as:

• Overpayment of income taxes
• Exposure to unnecessary financial risks
• Reliance on only Social Security for retirement income
• Insurmountable debt
• Inability to pay for children's college education

In addition, organized planning forms the basis to effectively budget for special expenditures, such as a child's education, personal debt and income taxes. An effective cash management plan will also help you choose the best way to meet both short-term spending needs and long-term financial goals.