FINANCIAL FRESHMAN #077
TL;DR → Zero-Based Budgets can’t exist in a vacuum, and obviously you’re not starting and ending each month with $0 in your checking account. Using your monthly needs, debt obligations, and autodraft commitments, you can easily calculate a revolving number to use in your budgeting practices. This is the number that should be in your checking account at the end of each month.
Budgeting Basics
For obvious reasons, we’ve talked about budgeting a fair amount on Financial Freshman. If you’d consider yourself brand new to the world of budgeting, I would recommend reading about the 50:30:20 first, followed by a more in-depth explanation of Zero-Based Budgeting.
Today, I’d like to expand on Zero-Based Budgeting by introducing a concept that has the power to transform how you feel about your money, not just how you track it. Even with a perfect budget on paper, many people still feel uneasy watching their checking account balance rise and fall throughout the month. That stress usually comes from not having a clear idea of what “enough” actually is. That’s where your revolving number comes in. Let me explain.
Your Revolving Number
In the world of manufacturing, companies all over the world aspire to be as efficient as Toyota. One of the core ideas of their operations is the concept of kanban (Japanese: かんばん), which is a simple visual system used to control the flow of manufactured goods and prevent shortages. Think of kanban as their way to maintain the Goldilocks Rule in their manufacturing plants—not so little that you run out, but not any more than you need.
Starting today, I’d like you to think about the money in your checking account the same way, and I’d like you to use a revolving number to put it to practice.
Put simply, your revolving number is how much money you “default” to having in your checking account at the start of each month. Your revolving number being too low may make you feel like you’re living paycheck to paycheck, even if your monthly expenses are well within your means. Conversely, if the number is too high, you are missing out on the growth that would come from having your cash somewhere more financially wise.
What should you aim for? The Goldilocks Rule for your money. Your revolving number should be high enough that you never have to think about money, without being so low that you have to “time” large purchases correctly. In the following sections, we’ll explain this further, and help you calculate yours.
Calculating Yours
This is a good time to remind you of one of our mantras on this website—personal finance is personal, and all advice you read online should be filtered through your own intuition. That said, this formula below is a helpful framework for calculating your revolving number, and it will work for a majority of financial situations.
To use this formula, you just need four pieces:
- Monthly Needs – In this context, be pretty strict with how you define “needs.” Think about those things that you would continue to pay even if you lost your job. Your rent, water and electricity bills, internet and car insurance count. Your fun money doesn’t.
- Autodrafts – Take an inventory of all things that will come out of your checking account automatically, and include them here. If you move $250 to your savings whenever you can, don’t include that. But if you have an transfer set up that moves this money every month on the 15th, then you should include it. Obviously don’t include anything that you already captured in step #1.
- Debt MMPs – “MMP” in this context means minimum monthly payment, and you would tally them up for this portion. What are the payments you have to make, or else debt collectors will come after you?
- Risk Factor – This is where you get to inject a little bit of your own personal preferences. Once you have your sum ready, reference the box below for your multiplier.
Let’s talk through an example!
Let’s assume that I need $2,100 to survive each month, I only have one autodraft of $250, and my debt MMPs total $300. My job security is strong and my employer pays me every week, so I feel comfortable being more lean. Per the math below, my revolving number should be $1,855. To make bookkeeping easier, rounding this to $1,900 or $2,000 would potentially be a good idea.
Applying Your Revolving Number to Your ZBB
If you’re ahead of me, you probably already see why having a revolving number is critical to successfully sticking to a Zero-Based Budget.
If you follow one of these budgets successfully, you will start and end the month with the exact same amount of money in your checking account (or close to it). With knowledge of your revolving number, you now know the “home base” that your money should get back to at the end of every month.
- If your revolving number is $3,000, and you’re starting the month with $3,200, you should over-budget by $200. That is, budget to intentionally spend $200 more than you bring in that month.
- If your revolving number is $3,000, and you’re starting the month with $2,800, you should under-budget by $200. That is, budget to not spend $200 of your income that month.
If you haven’t been adhering to a revolving number in the past, applying this logic is also how you can get started with one.
Final Thoughts
I recognize that this post is a little bit verbose. After all, we’re just talking about how much money you should keep in your checking account. Still, getting this number right is incredibly important. It impacts not only your long-term financial success, but also the sense of comfort and confidence you feel as each month of earning and spending passes by.
Calculating (& following) a revolving number will mean that:
- You won’t stress about typical monthly cash flow. If an expense is in your budget, and your budget is built around returning to a revolving number, then swipe away.
- You won’t ever have to worry about falling below account minimums or paying overdraft fees.
- You will maximize returns on your money, by not having excess cash sitting in your checking account.
- Your budget will be inherently more flexible. Did you go slightly over budget last month? You will see that in your ending balance, and will know exactly how much you need to pay yourself back next month.
- You will think about money less, which is a powerful step towards increasing financial freedom.
To me, these benefits are worth a quick pause.
See you next week!
