It has been said that the only thing that is constant is change! The same is true concerning your finances. It could be a major account that drops you, a medical emergency, losing a job, major vehicle maintenance, significant home repairs or a litany of other gremlins that could haunt your finances.
The First Step. The most important thing is to understand your cash flow. Cash flow is simply how much is coming in (income) and how much is going out (expenses) during a given period. Most cash flow analysis is done on a monthly basis but your circumstances could dictate a longer or shorter period. Make sure you account for every penny. The trip to the ice cream store, the haircut, the lottery tickets, school lunches, etc… Try to be as discrete as possible. At the end of the day you will have a miscellaneous category but try to keep it less than two percent of the total expense line. So, if your total expenses are $10,000, your miscellaneous category should be less than $200. Subtract your expenses from your average income and that will be your cash flow. A positive number is money left over and a negative number is the deficit you have each period.
Second Step. Forecast known future expenses. Future expenses could be a vehicle purchase, increased premiums with a teenage driver, college tuition, medical procedures, house repairs (new windows or paint), vacations or celebrations, aging parental care, etc. You could also have an income variation that must be accounted for as well. Bonus, tax increases or a spouse leaving the workforce are examples.
Third Step. Create your plan. You should have enough paycheck at the end of the month to have a little left over and pay yourself. If not, you need to create a plan to get their and tough decisions must be made. Your choices are to increase your income or decrease your expenses. Can you go down to one car? Get a part time job to supplement household income. Restructure some debt such as a refinance or consolidation loan on revolving debt. Sell your home and become a renter?
Fourth Step. Create an Emergency Fund. Most people end up in a financial crisis due to not having an emergency fund. An emergency fund covers lost employment periods, unexpected medical bills and marital discourse to name a few. How much should you squirrel away? As a rule of thumb, you should save six to nine months of expenses (see step one) plus any known future outlays (see step two). Getting out of bad debt (credit card debt, high interest loans, etc…) and establishing an emergency fund is 80% of the answer to financial independence. Keep in mind there is good debt. Examples are mortgage interest and education loans that increase your earning potential.
Fifth Step. Budget for a vacation or major splurge. There must be some fun in your life. Most financial turnarounds take 24-36 months. Following your plan will get very tiresome after the first 90 days. You must have something to look forward to during the dark days when the plan feels too constraining. Much like a diet, you have to be able to splurge with some dessert to keep yourself on track. Start small, maybe a nice dinner out or have a cleaning crew come to your home for a deep clean. Maybe you trade your car in for something different to drive. Find out what motivates you and keep your eye on the prize.
Refrain from spending any money that you do not have. That is what the emergency fund is for. Get off the credit card drug and begin to live within your means. Living debt free provides you with priceless control!