Monitoring Cash Flow

SAMSUNG CSC

“Rules of Thumb” have been suggested for numerous issues in personal finance: from the amount of life insurance a person should have to the maximum mortgage commitment a family should make. I’ve always been tentative about blindly accepting such rules. My left thumb is smaller than some of my friend’s, so it is an inexact, inconsistent measure. In a similar way, a financial “rule of thumb” may not provide the precision necessary to make a good decision.

For example, the “rule of thumb” is that in retirement a person needs the equivalent of about 80 percent of pre-retirement income for living expenses. Last month I set out to see how our financial situation matched up with this rule.

I immediately bumped against an obstacle. I’ve been fastidious about taking a financial snapshot at the end of each quarter. The quarterly graph I produce goes back to the early 1990s and shows the steady progress we’ve made in building a secure financial future. I have not organized data, however, on our income and expenditures. I cannot immediately report on what our spending habits have been nor follow the trajectory into retirement.

A cash flow statement examines the inflow and outflow for a specific period (month, quarter, year). Inflow includes salary and wages, business income (which for a pastor will include honoraria for weddings, funerals, and speaking engagements), investment income (interest, dividends, capital gains), and other monies received. Outflow includes savings and investments, fixed expenses (mortgage, taxes, insurance, etc.), and discretionary spending (eating out, clothing, vacations, etc.). Once the cash flow statement is formulated, a person can make comparisons with previous periods to identify patterns and trends. Interpretation of the data can assist in making modifications in the present and projections for the future.

Because I have not prepared a personal cash flow statement in years, I had to go to several documents to begin gathering the necessary data. That took a lot of time. The financial portrait that began to emerge, however, shows me that it would be extremely helpful to develop a more systematic way to monitor the ins and outs of our financial world.

I discovered that our grocery bill is about 30 percent higher than it was eight years ago. Further, I was surprised to see that we spend almost as much in restaurants as in grocery stores. In 2010, we spent 45 percent more on eating out than we did for the high-priced gasoline about which I’ve complained. Here’s a place we can make an immediate adjustment.

Our expenditures for utilities have gone up 18 percent in the past eight years while other housing expenses have had a minimal increase. Given the age of our house, we can expect increased expenditures in the coming years. The white plush carpet no longer lives up to its description.

Our two cars have served us well for many years. The amount we spent on gasoline last year is below the household average reported by the U. S. Department of Labor. But with aging cars comes increased maintenance, so we probably need to plan for escalating transportation costs.

Our health care program is structured differently than it was 10 years ago. Payroll deductions are higher and out-of-pocket expenses have increased. With regulations for health care reform still being written, it is difficult to see clearly what the situation will be 10 years from now. This is an area that warrants careful scrutiny in the years ahead, especially since my wife and I are moving into an age bracket that typically sees increased need for medical assistance.

Other financial classifications I did not look at in this review are financials (retirement savings, non-retirement savings, life insurance, etc.), charitable giving, entertainment and vacations, clothing, and other expenditures. These should be included in a thorough examination of cash flow.

As I reflect on this exercise, it seems prudent to develop a more robust way to regularly monitor our inflow and outflow. Since it will take at least seven sources of data, I need to find a way to bring it all together in one place.

Once I started getting senior discounts without mentioning my age to clerks, I began to think about retirement as something that might actually happen. What income will we need in retirement? A more detailed cash flow statement which delineates between fixed and discretionary outflow is necessary to fully answer that question. My preliminary calculation indicates that in our case the “rule of thumb” may be too high by 20 points.

Originally published by Pensions & Benefits USA.