When we get cash in the form of pocket money from our parents or salary from our employer

on the first of every month, it seems to disappear very fast. What did we spend it on ? We
have nothing to show for it. This happens because we do not correctly assess our expenses
and plan accordingly. Therefore, we need to be in control of our personal finances.

If we make a budget, a statement showing cash flows and a personal balance sheet we
know what our position is and what further steps may be taken to control the situation. A
budget, as we all know, is a statement showing future income, expenses and savings.
It is based on some estimates.

These estimates are one income which are our source of cash inflows and expenses which
are cash outflows. We need to prepare a personal cash flow statement which measures
cash inflows and cash outflows. By keeping a check on our cash outflows we may be able
to monitor our spending and allocate some amount towards savings.

Cash Inflows – Where does our cash come from ?

For working people, salary is the main source of cash inflows. Other sources may be
interest from bank deposits, dividends on shares or rent from property.

Cash Outflows – Where does our cash go ?

Cash outflows are in the form of expenses. Expenses will include both large and small. In
our daily life we incur so many small expenses like buying groceries, paying for our
bus tickets, paying bills for telephone, water and electricity which may all add up to huge
amounts. Paying rent, purchasing a car or paying your monthly instalments are examples of
large expenses. It is normally the small expenses which go out of hand and is difficult
to keep track of them. Recording these transactions will help you sum up your cash
outflows.

Preparing a personal cash flow statement

Now that you have an idea of your cash inflows and outflows, it is easy to prepare a
personal cash flow statement. First of all you need to record your cash inflows, i.e., how
much is your income, how much cash you receive from interest or dividend or any other
source.

Then, you may add up your expenses for that period (it may be monthly or
annually). Thereafter, by deducting your expenses (outflows) from your income (inflows) you
will arrive at the figure of net cash flows.

Some tips about budgeting

They’re the only practical way to get a grip on your spending and to make sure your money is
being used the way you want it to be used.
Creating a budget generally requires three steps.

 Identify how you’re spending money now.

 Evaluate your current spending and set goals that take into account your long-term
financial objectives.
 Track your spending to make sure it stays within those guidelines.

Electronic devices like mobile phone, calculator, digital diaries, laptop, etc., can be used for
recording income and expenses.

You can create your personal financial statement so as to get a quick check on your financial
position.

Don’t overburden yourself. Monitor your spending but don’t get over involved with accounting
for every rupee

Example: Arun after finishing college gets a placement as an Assistant Manager

with a business firm exporting garments. The firm pays him a salary of 27,000/- per
month. After paying taxes of 2000/- Arun wants to monitor his spending so he
decides to prepare personal cash flow statement for the last month. Arun does not have
any other source of income from interest or dividends. He has expenses like travelling
to his place of work, he pays `. 3000/- as conveyance p.m. to the taxi driver, his
mobile telephone charges costs him `. 1000/-, he contributes `. 5000/- to household
kitchen expenses, he decides to buy a gift for his parents for `. 2500/- from his first earnings
and `. 3000/- he spends on tea/coffee with his friends.

Personal cash flow statement for Arun

Cash inflows

Salary 27000

Interest on deposits 0

Dividend income 0

Less income tax 2000

Total cash inflows 25000

Cash outflows

Travelling expenses 3000

Mobile telephone 1000

Household expenses 5000

Parent’s gift 2500

 Recreation (tea/coffee) 3000

Total cash outflows 14,500

Net Cash outflows 25000-14580 = 10500/-

The excess cash of 10,500 he can allocate to savings and other purposes. Basically, to
increase your net cash flows you will either have to earn more or spend less, i.e., maximize
cash inflows and minimize cash outflows

12 Factors affecting cash flows:

We will have to analyse both cash inflows and cash outflows. It is only the net cash flows
which enhance your wealth since you can save it or invest it further to earn a higher income.

Cash Inflows

Your income is the major source of cash inflows. Your qualifications and the stage at which
you are in are the two factors affecting your income level. Then other sources are
interest income, dividend, rent from property etc.

Stage in career path

People at initial stages of their career earn a lower salary. As they grow and develop
in their career, their salaries increase, allowances increase, their experience enables
them to get other higher post jobs, etc. This normally has a direct correlation with your
age. The older you get your salary structure and status improve. But it may so happen that
when jobs are changed older people do not get the commensurate salary. Your cash
inflows or your salary therefore depends upon your career and the stage of your career.

Type of job

Some jobs are very well paid. In India, professionals or people with specialized skills earn
much more. Engineers, management professionals, lawyers, are usually paid higher
salaries. Doctors who are also highly qualified, unfortunately, in India, are not well
paid. If you are self employed, then your cash inflows will depend upon the hard
work and the time, energy and dedication you put into your work.

Number of working people in your household

The households’ cash inflows also depends upon the other earning members in the
household. Obviously, the household with more than one income earner will be more
comfortable and the total cash inflows will increase.

Cash Outflows

Cash outflows are the expenses incurred on various items and assets. These depend
upon the person’s family size, age and consumption patterns

Family size
If you are the only earning member and supporting a large family, then expenses will be
high. It also depends upon the number of school going children where high fees are
to be paid, expenditure on clothing, transport, etc., will also be high. Where the numbers of
dependants are less, expenses are lower and these households normally have a capacity to
save.

Age

As people grow older their expenses change and they may tend to spend on
assets like cars, houses, land, etc. Their expenditure on school tuition fees, household
items decreases and they have more cash to spare for purchasing a house or a car or going
for vacations abroad. And then they may still have some money to spare for investing.

Personal consumption patterns

People have different consumption patterns, some like to spend extravagantly and spend
most of their money on expensive things as soon as they get their salary. Middle class
families usually spend their money in the beginning of the month and they are left with little
to save. Then there are some people who are always saving for some contingency or some
dream house they want to buy. Their expenditure is the bare minimum but their
savings are large. Cash flows will therefore depend upon consumption behaviour.
Savings will also depend on a family’s/individual’s consumption pattern and spending.
Consumption pattern is also affected by the amount you have to spend. The income
you earn will determine your consumption behaviour like if there are two persons earning
in the family, that household spends more.

Preparing a Budget

In the personal cash flow statement, we recorded actual income, expenses and savings. If
we need to find out net cash flows in the future we can forecast the cash inflows and
outflows for each item on the personal cash flow statement. This cash flow
statement based on forecast income and expenses for a future time period is called a
budget.

A budget may be prepared to determine whether your income (cash inflows) will be sufficient
to take care of the expenses (cash outflow) that you are likely to incur in the next
month. It is possible that your expenses (out flows) are less in the next month and you
may be able to save the excess amount of cash for purchasing something you want.
Or else your expenses will exceed your income (cash inflows) and you will have to make
some kind of arrangement either borrow or pay through your credit card to cover your extra
expenses. If you know in advance what is to be done, you are better prepared to face the
situation.

In the same example taken earlier, suppose Arun anticipates his spending to go up next
month by `. 1000/- due to extra travelling and he would have to pay `. 12,000/-
towards his father’s medical treatment.
Revised personal cash flow statement

Cash Inflows Next month Last month

Salary 27,000 27,000

Interest on deposits 0 0

Dividend income 0 0

Less income tax 2000 2000

25,000 25,000

Cash Outflows

Parents’ gift - 2500

Travelling expenses (1000) 4000 3000

Mobile telephone 1000 1000

Household expenses 5000 5000

Recreation 3000 3000

Medical treatment 14000 -

27,000 14,500

Net cash flows (-2000) (+10,500)

Thus, we see that next month there is an unexpected cash payment of medical
expenses for which Arun will fall short by 2000/-. He then has to arrange for this
contingency.

Create your own budget

Assess your monthly expenses.

Make sure you record all your regular monthly expenses, including what you spend
on eating out, entertainment and hobbies.

Total your earnings.

Calculate how much you make per month, including any money that you receive
from investments and other forms of residual income.

Match your expenses with earnings. This will test how effective your budget is and how
much you have left over at the end of the month.

Rework your budget.

If your expenses exceed your income; you will have to cut down unnecessary expenses.
 Keep some money for debt reduction.

Your budget should have provision for paying off your debts each month.

In case of huge debts it is better to sacrifice and make a lump sum payment. A part of your
income may be saved for an emergency, retirement investments, vacation, family
celebrations, etc. These financial goals may be highlighted in your budget.

Put your budget to work.

Now that your budget is ready covering all expenses and financial goals, make sure you
follow it and live within it.

Assess your budget

If you are not able to live within your budget, you need to limit your spending and rework your
budget. Be realistic about your spending habits

Why prepare a budget?

Preparing a budget actually helps in anticipating cash shortages, checking the

accuracy of the budget and forecasting net cash flows for future .

Anticipating cash shortages

If you are likely to have a cash shortage in the next month you can make
arrangements to overcome it. Maybe you could withdraw funds from another account and
manage somehow. If the amount is large, you might need to borrow from a friend or
relative or maybe take a loan against a fixed deposit or dissolve the fixed deposit.
The deficiency can be covered if one is forewarned and has sufficient time to arrange
for funds. An emergency fund could also be created and some money kept aside for
such purposes.

Assessing the accuracy of the budget

Since a budget is a statement of anticipated cash inflows and outflows, it will be

generally prudent to compare the actual cash flows with forecast cash flows.
Usually, we tend to overestimate cash inflows (income) and underestimate a cash outflows
(expenses), as a result the net cash flows are less than expected. Budgeting, therefore,
helps us to limit our spending so as to adjust to the limited income inflows. Or else, we try to
increase our income to pay for those extra comforts.

Forecasting net cash flows

 Budgets can be prepared weakly, monthly or annually. Expenses can be forecast
months in advance and by following the same procedure a sum total of cash outflows can
be determined. Similarly, if there are any other sources of income like interest on fixed
deposits, or rent from property they can also be summed up for each period and net cash
flows can be computed. In this manner, at least over the next few months, things can be
quite accurately predicted.

Positive net cash flows

If positive net cash flows over a period of time are anticipated, you can plan for
purchasing property, can or actually buying in instalments and pay equated monthly
instalments (EMIs) towards owning an asset. These positive net cash flows are your
savings which can turn into investments. You may invest your savings in fixed deposits,
mutual funds, or share market.

Budgeting may enable you to value your financial health. In case there is any
recklessness, which is impossible to eradicate, efforts can be made to minimise its influence.
At the same time budgeting also ensures that your money plan grows steadily over a period
of time. It generates a sense of financial well-being as we tend to be less stressed about
managing money and are prepared for life’s contingencies in future.