Real Life Example: “My company’s laying people off. We have some big expenses coming up. Will we make it?”
One of the most powerful things you can do to reduce the anxiety of an uncertain world and the risks it poses to your personal finances is build a simple cash flow projection. Do you have an Emergency Fund? Check. Are you doing some budgeting and expense tracking? Check. Cash flow projection? Um, what?
Given what you know and some of what you don’t know, will you still have money in the bank at the end of the summer, at the end of the year, next spring? Keeping this question answered is both easy and powerful.
Step 1: Known and Steady
First you need to capture your known and steady income and expenses. These are the amounts that you probably know the best. You know how much income is deposited into your checking account each month, and you probably know how much you spend in a normal month.
Those amounts are both known and steady, meaning you know about them and they happen every month.
Write down those two numbers: steady monthly income, steady monthly expenses.
Step 2: Known and Lumpy
Now make a list of items that are known but unsteady, or lumpy. These might be income items (like a bonus), but the list of expense items is probably longer: a vacation, an insurance payment, property tax payments, or a planned home improvement.
Write out your list of known, lumpy expenses and what month you expect them to happen.
Step 3: Unknown, Steady or Lumpy
This is the group that can be scary, the “what-ifs”. What if I lose my job? What if one of us gets sick? When we talk about emergency funds, we’re talking about coverage for these types of unknowns. Instead of trying to predict the future and guess what these might be, just think for a moment about the ones that bother you, the ones you already think about.
Write down 1-3 What-If situations you actually want to examine. Don’t worry about numbers yet, just the situations for now. While doing so might feel unpleasant or scary, the process of writing it down and later examining the possible impact will reduce uncertainty and either 1) build confidence that you can weather a storm or 2) inspire you to change your course accordingly.
Step 4: Make a Happy Path Projection
Now make a simple projection across 6-18 months. Use a spreadsheet if you can. For each month, here’s your equation: Starting bank balance + steady income – steady expense – known, lumpy expense (if there is one for that month) = Expected ending balance. You don’t know what your bank balance will be at the end of the month, but now you have a projection.
Now setup the same equation for next month, using this month’s projected ending balance for your next month starting balance. Repeat for 12-18 months. Revisit the known, lumpy expenses – are they all there?
You should now have a projection of your bank balance at the end of that 12-18 months. How’s it look? Do you need to adjust anything? Any surprises? Everything OK?
Here’s the last bit: at the end of each month, record your actual ending bank balance on top of what you projected. This should replace the starting balance for next month and adjust your entire projection. This is how you keep the projection fresh.
Step 5: Adjust Your Projection for “What-if” Scenarios
Lastly, if you want to stress-test your forecast for something unexpected and undesired, like a layoff, you can do that. Using the layoff example, the known, steady income number will drop with your loss of income, and that drop might be partially offset by unemployment benefits or other temporary benefit. Adjust your model to work that in, and see how it looks. How many months before you run out of cash? Do you need (or simply want) more in your emergency fund? What expenses will you cut if that event happens?
I hope you’ve found this helpful. Please drop me a line and give me your real life example questions.