Saturday, April 9, 2011

Cash Flow Types

Not everyone can easily live within a budget.  There are a few types of cash flow model I want to present to you with names so you'll recognize which you fall under when you see it.  Being able to recognize your cash flow model will help you determine what kind of budget you'll be able to lay out and how easy or difficult it will be fore you to stick to.

The two driving factors are Income and Expenses.  We have either a Variable Income or a Fixed Income, and we have either Variable Expenses of Fixed Expenses.  This gives us four types, any of which we may move between during the course of our lives.

Four Patterns

Fixed Income, Fixed Expense   (FIFE)
Variable Income, Fixed Expense  (VIFE)
Fixed Income, Variable Expense  (FIVE)
Variable Income, Variable Expense  (VIVE)

The acronyms, FIFE, VIFE, FIVE and VIVE actually have some helpful mental cues to them.  FIFE is like pleasant music - it is the least stressful because you can plan your budget to a penny and not worry about deviating from it.  It is also the least likely to be encountered unless you are a VERY frugal pensioner, have a stable job and simple life, or recipient of a trust.  VIVE on the other hand is like it sounds... vivacious - exciting and a bit dangerous.  When all things are variable, you have a much harder time planning, but it is possible.  This is what small businesses typically encounter.  VIFE is what the self employed typically see - job to job income, regular house payments.  FIVE is typical of pensioners with medical problems, families with children and so on.

Each of these cash flow types can be handled with some degree of budgeting and planning.  We don't have to face these different modes of cash flow on a hand to mouth basis, but it takes a lot of discipline and some good foresight to get in front of and stay on top of.

Let's start with FIFE as that's the easiest and most common for college grads and single or married working folk with no children.  With a fixed cash flow, planning is as simple as setting a budget that keeps you within your means, covers the basics like rainy day savings, giving, debt reduction and having some fun, and then sticking to it.

Later in life, you may find yourself with debt but unemployed - ala VIFE.  Your income has just become variable (with a minimum threshold of ZERO or at least unemployment benefits) but you still have expenses. Planning in this situation is going to be a little tricky.  First thing, start looking for work and take anything that pays.  If it's not "your thing", make sure your clear with the employer that it's short term and you're actively seeking your ideal job of "x".  Then you need to look at what you've got saved, what your monthly expenses are and how long your savings will pay those expenses.  This gives you a timeline for other planning activities outside of finding a job - namely asset and debt reduction.  This typically means getting rid of things that are a source of ongoing expense.  You might have to sell your car, move to a cheaper apartment or in with friends or  family.  Consider renting a room instead of a whole place all your own.  Definitely cancel the cable and if you have a cell phone and can go to the library to check your email, get rid of you phone plan for now as well.  Or ditch the cell phone plan and go to a prepaid phone, which is typically cheaper over the course of a year.  Be resourceful and don't cling to material possessions.  The temporary security they bring you is easily destroyed by the debt you might take on to keep them.  Keep your credit card tucked away for emergencies only.  Don't use it as your own personal bail out, you'll just bury yourself in debt maintenance and, as Ben Franklin said: "he who takes a debt gives another control over his liberty."

Hopefully, you're making your full time job finding the right paying job, but your part time occupation is going to be handling your expenses with dwindling resources.  This is a great time to make some life changes regarding the standard of living you've adopted.  Do you really need all that "stuff"?

Another challenging but equally approachable cash flow model is FIVE.  You have a fixed income but your expenses are variable.  Maybe this is because you have kids and they have random registration fees for sporting clubs or need extra supplies for school projects.  Or perhaps you are on social security or a pension and you are having the usual old age symptoms of random Dr. Visit here, random prescription there.  The important thing here is that you have finite resources.  So you need to plan according to that with a reasonable allowance for expected variables.  Usually we would add up our expenses and subtract from our income.  But to manage the variables, we're going to have to determine a min and max range that is expected.  Add up all the variable costs for the past few years and average them to get this range zeroed in.  Then, in your budget, set aside enough each month to cover the necessary variable expenses.  If this leaves you in the red, look to your fixed expenses for things you can restructure, down-size or eliminate until you have a comfortable monthly budget that will absorb your variable expenses over the course of the year.

Finally, VIVE.  This is more common to small businesses or self employed people who own a business that has a lot of consumables or inventory that experience variable or seasonal demand.  My sister is a bakery coordinator.  Her job is to look at the amount and types of bread being bought month over month at each location she manages and determine how much bread of each type to buy materials to make in the coming month.  This is a complex projection model that is heavily data driven and requires a lot of planning.  The full detail of this is beyond the limited scope of this article and I hope to write something more comprehensive with my sister's aid in the future.  My take on the VIVE cash flow model, though, is that in addition to projecting your expenses, you need to be projecting your income as well based on trends.  This means a LOT of data gathering which in itself can overwhelm a small business, which should give some idea as to the value of a good accountant and solid book keeping practices.

Summing it up, regardless of your cash flow type, you will want to use a budget to keep your expenses inline with your income and to plan for the future.  That's the big thing - the future is what we're all heading for, so let's get there in the best shape possible. Have questions or feedback? Leave a comment!

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