Friday, February 8, 2008

Improving my Cash Flow Process

After reading a couple of PF blogs describing their cash flow process, I decided to review and update mine. From the comments on those posts it’s apparent that a lot of folks operate their monthly cash flow on slim margins. Quite a few are nearly zero!

I would like to squeeze as much efficiency as possible out of the process, but I am not willing to operate that close to default. I will always have a cash cushion in my checking account, because I never want to have an overdraft and I don’t want to be constantly checking the account to see when a check cleared. Who needs that kind of additional stress? Life is too short for that.

So, it's necessary to find a balance. I want my hard earned cash making interest for as long as possible, not sitting in a zero interest checking account, and no overdraft worries. Let's take a look at my current cash flow system and figure out how it can be improved.

My current cash flow process follows:

  • Direct deposit approximately 20% of my pay check into my checking account. It’s a bricks and mortar type credit union that is affiliated with my place of work. I am still dragging my feet on going with an online only bank. Maybe with the new availability of Checkfree, I will finally make the leap.

  • Almost all of my bills and expenses are first paid with my credit card (cash back rules). I then pay off the credit card each month via my checking account.
  • Direct Deposit the remainder of my pay to a Vanguard Money Market account. The MM account is currently paying 4.11% interest. I use this account to fund my dollar cost averaging, value averaging, brokerage account purchases and it’s my emergency reserve.
  • For any special or unusual purchases, I must transfer money electronically from Vanguard to my checking account.

For the most part this cash flow system works well, but sometimes extra cash builds up in the checking account and earns no interest. For instance, right now I have $3,678 in my account. That's more than I need in one month. I am missing out on $50-80 of interest over a year by not managing this account more diligently.

Setting a target account value
Just for fun, I thought I would do a more rigorous analysis to figure out an optimal target amount for my checking account. To do that, I need to get my cash flow numbers and decide on a sufficient cushion.

I fired up MS money to build a report of monthly cash flow for each month over the previous year. The software has an export feature to Excel where I added it all up and calculated the monthly outgo.

Monthly expenses do vary substantially, since there are some one time charges like property taxes, new tires and insurance, etc. So, I removed those one time charges and ran the average again. That number was just short of $1000/month for expenses.

Now, for a cushion, I plan to use 1X my average monthly cash flow and subtract out the amount that I direct deposit each month. That makes my target checking account value at $900.

I will still need to make one time money transfers from Vanguard to my checking account for any big ticket payouts. But, at least the money will have earned a little interest in the meantime. And another benefit to limiting the cash in a checking account is that because it takes time and effort to make a transfer, I have more time to re-consider if I really need that big ticket item.

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