Cash flow management: Envelope budgeting

The Foundation for Credit Education says:

For individuals who don’t like to work with figures, the “envelope method” provides a simple way to build a savings fund. This convenient system allows you to set aside money each week for various expenses without making frequent trips to the bank or keeping paper and pencil records.

What do you need?

Does this even really work?
The envelope budgeting system has been around for a long time. Working on the principles of paying yourself first and spending money only according to your plan gives you a sense of control that you otherwise wouldn’t. It’s right there in the school of KISS.


How does it work?
Let’s do it manually before you even think of buying or using software so that you know the principles behind the system. This illustration uses 10 actual envelopes.

  1. Get your past utilities and phone bills. You will be basing your budget on the amounts from your previous bills so that you’ll be setting realistic expectations.
  2. List down the following on a piece of paper or in Excel:
    • Monthly income (fixed or average)
    • Fixed expenses
      • Savings (Pay yourself first –10% of your income)
      • Utilities
      • Credit card repayment
      • Loan/mortgage
      • Gym membership
    • Variable monthly expenses – use separate actual envelopes
      • Meals
      • Entertainment (eating out, movies)
    • Big-ticket items (one-off)
      • Summer vacation
      • Furniture
      • Down-payment for a house or car
  3. ALLOCATE.
    • Divide your paycheck by 1, 2, or 4 (depending how many times you get it). That’s MONEY GOING IN.
    • Divide your total fixed monthly expenses as well (1,2,or 4). This is the amount you automatically set aside by auto-debit to a separate savings account you use for spending or withdraw this amount and keep it in an actual envelope. That’s part of MONEY GOING OUT (NOW).
    • Divide your variable monthly expenses by 2 or 4, depending on whether you like to keep your spending envelopes by week or every 2 weeks. This is part of MONEY GOING OUT (NOW).
    • Divide your big-ticket items by how much time you have left. This is part of MONEY GOING OUT (LATER). If you want to buy a TV 4 months from now, set aside a fixed amount every paycheck so that you’ll have enough when it’s time to buy. Just think how relaxed and in control you’ll feel when you walk into that electronics store knowing how much you can and will spend. It’s very gratifying.
    • If your money runs out, say for grocery, it’s up to you if you can give up that extra fruit or if you see you still have money left in your Entertainment envelope, you’ll transfer funds from there to your Grocery envelope.
  4. TRACK
    • Always carry a pen so you can write down how much you spent for what outside your envelope. It’s definitely easier to write it down at the time you buy something than to accumulate receipts which can get so boring or intimidating you’ll just give up on it. So carry those envelopes with you in your planner or in your wallet and mark them with a pen every time you buy.
    • When you use your credit card for, say, dinner under Entertainment, transfer the cash from the Entertainment envelope to the Credit card repayment envelope. Don’t spend money you haven’t earned.
    • Every month or every 2 weeks, check out your spending envelopes. How much is left? How much did you transfer? If you have money left over, you can transfer it to your Savings envelope rather than “reward yourself”.
  5. COMPARE
    • As you can see in the illustration, we haven’t been able to set aside money yet for the vacation and furniture since the expenses based on actual still just zero out. In a few months, when expense are brought down by discipline and continuous cutting back, we should be able to set aside P500-1000 to contribute to the Vacation fund.
    • Isn’t that what the Savings envelope is for? No. The savings is meant to build up an emergency fund good for 6 months. This is a good rule of thumb for when you get sick, or a family emergency arises, or you get sacked.

But wait!
What’s exciting too is that we planned for only 2 paychecks per month.

(2 paychecks / 1 mo.) x 12 mos. = 24 paychecks

Something’s fishy! Hm. Look again.

(52 wks / 1 yr )x (1 paycheck / 2 wks) = 26 paychecks/year

There are 2 paychecks that will come in that you won’t be spending out. We didn’t even include 13th month pay yet. So you’ll have extra money left over just by spending only what’s in your envelopes.

Where can I find out more?

If you want to get more into envelope budgeting, you can read a free excerpt (I had fun reading this) of Money for Life: Budgeting Success and Financial Fitness in Just 12 WeeksCash flow management: Envelope budgeting, which retails at $9.95. It certainly opens your eyes about the practicality of the envelope budgeting system and how retiring comfortably and controlling debt is possible. It has a storybook approach rather than how-to-this how-to-that or motivational Robert Kiyosaki “I promise you riches” sort of book.

Here’s a video presentation that shows pretty well how Envelope budgeting works.

Here’s also a helpful 4-page budget discussion from Snowmint Creative (more technical and shorter reading than the “Money for Life” excerpt.)

Is there software I can use?
The following are based on the envelope budgeting system. For those based in the Philippines, right now I’d say your best bet would be Quicken. The Mvelopes team has yet to expand services and I’m still evaluating the other products.

Free/Open-source

Paid Software

I hope you got a practical grasp of envelope budgeting. It’s as simple as your money in equals your money out to different saving/spending envelopes. No overspending.
If you want a more technical method, we’ll take a look at spreadsheet budgeting next.

May 28, 2007 | Filed Under Cash management, Financial Education 

Comments

3 Responses to “Cash flow management: Envelope budgeting”

  1. Importance of personal finance in your life — MarieCasas.com on July 27th, 2007 12:24 pm

    […] many hours a week do you give to planning your budget ? Considering whether you really need that new Mango top? Adding up to realize you spent P5,000 […]

  2. Aaron Hampton on August 4th, 2007 12:47 am

    Another very capable envelope budgeting program is CommonCents 2007. With CommonCents, you can see all of your accounts and all of your budget envelopes on one screen. You can download a free 60 day trial at http://www.CommonCentsSoftware.com. Try it. CommonCents is common sense.

  3. Pinoy Web Startup » 7 Must-Do Tasks Before You Start Up - Starring Philippine web technologies on February 13th, 2008 12:04 pm

    […] learning how to make a budget, stick to it, and see where you can cut corners. I used to buy nice clothes or shoes at least once […]

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