Cash flow management involves budgeting, planning for emergencies, and saving money.
There are two types of budget items: discretionary and non-discretionary expenditures. Discretionary items are flexible. We can prevent paying them or time the payment schedule in advance. Non-discretionary payments have a deadline and we must pay them on time.
There are various budgeting strategies to minimize expenditures. Some examples include refinancing, reallocating assets, and sheltering income from taxes. Refinancing involves consolidating outstanding loans, lines of credit, and credit cards into one mortgage on the primary residence or a second mortgage (also known as a home equity loan or line of credit). Refinancing gives homeowners a new first mortgage by paying off the current loan then furnishing additional cash to pay other obligations. If current mortgage rates are lower than the existing first mortgage, a new loan could allow borrowers to save on monthly payments. It is important to have a combined loan to value less than 80 percent to avoid mortgage insurance. Home mortgage interest is also tax deductible.
Reallocation involves converting assets for more productive use. For example, distributing money from a Roth IRA, after meeting IRS requirements, is using after-tax dollars without a penalty or tax consequences.
Sheltering income from taxes is a matter of utilizing a qualified plan to benefit from a tax-deductible savings program. Incorporating children’s assets into a custodial account or trust can benefit from the lower kid's tax rate.
It is also important to review income tax withholding at least annually.
It is imperative to have liquid assets for an emergency. When planning an emergency fund the bottom line is adequacy of reserves. Typically, three to six months of fixed and variable expenditures is reasonable. However, we prefer to have multiple streams of income. If there is only one income stream, greater planning is required. Having many income streams provides greater financial stability. For one-income stream, six-months of expenditures may be an adequate emergency fund. For two or more income streams, three-months may be sufficient. When planning the emergency fund, a very important consideration is liquidity and marketability. Liquidity is the ease of converting assets to cash with little or no risk of loss to the principal. Marketability is the ease of selling an asset. The best place to save emergency funds is cash or cash equivalent securities. Liquid substitutes for cash include checking, savings, and money market accounts, U.S. Treasury bills, short-term certificates of deposit, and money market mutual funds. It is important to reinvest interest and dividend payments to help build the emergency fund. A reasonable rule of thumb is to save 5% of gross income until the emergency fund is to the desired goal.
TIP: Track all money in and out for the next thirty days.
QUESTION: What do you do to manage cash flow?
Chris Bryant is an American financial advisor.