A basic part of family planning begins with cash flow management. In many cases it is this first step that determines the ultimate financial successes of the household. By understanding cash flow, the family can make good decisions that will enable it to avoid unnecessary debt, borrow responsibly, accumulate wealth for the future, and plan for major needs such as education expenses or retirement.

My experiences have shown me that many families and individuals do not have a sound understanding of how they spend their money. Due to the ease of purchasing with credit cards, its accompanying deferral of debt, and the proliferation of ATMs, it is not uncommon to encounter situations where the family unit has no idea how much it costs them to live.

The cash flow statement to the family unit is similar to the profit and loss statement for the business. It tracks income in and expenses out. An easy way to develop the cash flow statement is to begin by setting up a simple spreadsheet that lists sources of cash coming in and expenses going out.

Cash may come from a variety of sources including, but not necessarily limited to, employment income of the working household members, gifts, realized investment gains and losses (a subtraction), net rental income earned, interest earned and reinvestment of dividends and capital gains in non-retirement investment accounts.

I like to categorize my expenses into three main categories: fixed costs that must be paid each month, variable living expenses, and discretionary expenses.

In the book, How to Run A Business In Trouble, the author advocates breaking expenses between those you had to pay to keep the bank from shutting down the business, such as bank loans and insurance, and all others. The former you pay first and the latter you negotiate or make choices with. The smaller the former amount is in relation to income, the better. The lesson of this is simply to lower fixed costs such as mortgages, loans, and credit card payments for financial health!

Variable living expenses make up the bulk of our remaining expenses. These include the many basic expenses over which we have some choice as to how we spend. These include utilities, household upkeep and maintenance, food, transportation costs, insurance, personal care and clothing, subscriptions, and club dues.

If we take the total of these two expense categories and subtract that from our income, the remainder is money we have available for discretionary spending.

Discretionary expenses include expenses we choose to incur, although they are not essential to our basic lifestyle, including gifts to charity and gifts to others, recreation, travel, unaccounted-for-spending, hobbies, and savings in retirement and other investment accounts.

Knowing where we can make choices is the most important part of this exercise. It has been said that there are two kinds of people: Those who spend first and save what’s left and those who save first and spend what is left. Invariably, the former ended up working for the latter. Taking that to heart and knowing where you are spending money for wants vs. needs is the first step in developing a sound financial plan.