There are numerous types of financial statements. We’ve talked about a net worth statement and a cash flow statement. I believe budgets require no formal introduction! When producing your cash flow statement (outlining your income and expenses), you may have noticed it seemed an awful lot like a budget. And you would be right. But there are key differences.
The first key difference is the direction in time. A cash flow (or income statement, for our purposes) is a look backward in time. It illustrates what happened over the past year – what sources of income your household had and what were your outflows? A budget, on the other hand, is a projection forward in time – what you expect or desire to spend over a certain period of time.
A second difference between the two statements is subtler. Because the cash flow statement is history, it is a snapshot. “Here is a picture of your financial life last year,” is what it says. A budget or spending plan, on the other hand, is fluid, a view of “what could be” or “what should be, so we don’t go broke.” You cannot change or fix a cash flow statement. But a budget is wonderfully fraught with possibility and hope.
The advantages of a cash flow statement are two-fold. The backwards look allows you to evaluate how you did over the past year. It is also a perfect launching pad for your new spending plan or budget. From a financial management standpoint, understanding where you came from and where you now stand is imperative to get where you want to go.
Budgets are much maligned. People talk about them in the same way that they talk about diets. I think this is a mistake, on both counts. Make it a positive thing – if you need to improve your eating habits, implement a healthy eating plan. If you need to improve your financial habits, implement a spending plan.
See? Isn’t that more optimistic? Use your cash flow statement to see how you have been doing, and then use your newfound clarity to plan the future. What areas can you cut back to increase your savings or debt pay-off goals? Celebrate the parts you got right, and vow to improve the areas that you didn’t. Then work with your spending plan, adjusting and adapting it as you move along and learn more about your spending habits. If you treat it as a living plan versus a dusty old financial statement, you will find it much more useful.
What are your thoughts? Are spending plans a curse or a cause for celebration? Share your ideas below.