- Samuel Johnson
This analysis need not be overly complicated. Analyzing regular income in particular is often quite simple. Perhaps 90% of family income comes from salaries, with a small amount from consulting income or dividend-income. Our spending of course, is usually much more varied, with (relatively) "fixed" expenses, such as the monthly mortgage payment, car payments, groceries, utilities, retirement plan contributions and insurance and "non-fixed" expenses such as restaurants, entertainment, clothes, and vacations.
By analyzing our spending we can develop a measure of cash flow, the amount of income gain or loss for a given period, such as a year or a month. Analyzing cash flow over at least a few months will tend to give a better measure of long-term cash flow since it tends to smooth out the volatility in expenses that we all experience.
What we generally like to see with our cash flow is that the long-term trend is positive, indicating more income coming in each month than expenses. This also often coincides with declining debt levels and/or increases in accumulated assets, either almost always a good sign.
On the other hand, if monthly cash flow is consistently negative, more careful analysis is needed to see where spending can be cut. Perhaps eating out frequently or buying unneeded new clothes are possible areas to tighten the wallet in. Maybe going to fewer concerts, movies or sports events would be appropriate. Vacations are often a place that can be cut back with cheaper alternatives.
When a large part of monthly spending is "discretionary" or "non-fixed", it is usually easier to cut back one's budget. If I see that I'm spending an average of $200 a month over my monthly income but I see that I'm spending $200 a month at Starbucks, well, it should be pretty easy for me to come much closer to a balanced budget.
A bigger problem arises when a very large percentage of one's finances are "fixed" expenses, where the majority of your dollars are already accounted for when they get to your bank account. Perhaps you're making $5,000 a month (after taxes), but your mortgage, car payment, grocery expense, insurance, gas, and utilities are accounting for $4,500 a month. An individual in such a situation is going to feel much less free financially than an individual with $5,000 a month income but fixed expenses of just $2,500 a month. The latter individual will have more money to spend on discretionary expenses, such as going out to eat or shopping for clothes or books.
One variable that can make a tight budget even tighter are credit card expenses. Besides the fact that buying with credit cards tends to lead to more discretionary spending, carrying credit card debt over from month to month, with the usual high interest that credit cards charge, is going to be one more "fixed" payment (or worse, increasing), that will make it difficult to balance one's budget. In such a scenario, goal number one should be reducing debt on that credit card, and hopefully eliminating the debt, and probably the credit card, if you already have a propensity to get into credit card debt trouble.
More generally, if you have a cash flow statement that is chronically negative, combined with high fixed expenses, hard choices may be necessary to balance your budget. Perhaps a car should be eliminated or a smaller house or different living environment. Maybe a cheaper phone, cable or internet plan would help. Depending on your age and driving history, it's possible that your auto insurance could be reduced, especially if you drive less and/or drive a less costly car. If credit card interest is a part of these fixed costs, besides trying to pay down the debt as quickly as possible, a call to your credit card company to reduce the interest rate might pay off, especially if your credit rating is good. Transferring the balance to another credit card sometimes is worthwhile, though usually if it's accompanied with increased discipline to limit further credit card usage.
Cash flow is so important because it has a large impact on whether a family's financial assets, and financial security, will rise or fall. A continually negative cash flow usually leads to increasing debt levels, while a regular positive cash flow often leads to declining debt levels and/or rising asset levels. The financial benchmark of net worth is the measure of a family's assets after accounting for their debts. This means tallying up the value of household assets (stocks, mutual funds, retirement accounts, checking accounts, etc.) and non-financial ones (such as house and car). Then add up all household debts and loans, including mortgage, auto loans, credit cards, student loans, and other debts. (There are many websites with available "net worth calculators," such as here.) Comparing assets to debts results in a figure of net worth and a benchmark that can be used to measure long-term progress. Ideally, we would like to see this number rise over the long-term, not necessarily every year, but at least over longer periods of 5, 10 or 20 years. (An exception is during retirement when assets are often used for living expenses, and in which a moderately-declining net worth is often appropriate.)
Lastly, although the basics of measuring cash flow and net worth are rather simple, the solutions to dealing with declining or negative net worth or negative cash flow are often not simple. Every family is different and different solutions are often needed. There are many professional sources, including some free resources at consumer debt non-profit agencies that can provide guidance. But it is fairly certain that there is little downside to doing more regular analysis into the state of one's finances. Hopefully it will produce more knowledge and lead to improving long-term finances. If on the other hand, problems are revealed through such analysis, then efforts can be made to solve the problems. It is nearly certain that the problems will not go away on their own. In general, avoiding reality is not a great financial planning strategy.
As in many others of life, sometimes making a few changes can lead to big improvements.