Photo by Sora Shimazaki
Envelope budgeting can help business owners better understand their expenses and manage their money. It’s a creative budgeting solution for those interested in getting a better handle on their business’s cash flow.
What is envelope budgeting?
Envelope budgeting is a popular method of saving money and managing spending that uses envelopes to organize and manage expenses. Envelope budgeting is a common personal finance management technique, but you can apply the principles to small business cash flow management too.
Using this budgeting method, you can use envelopes to store cash for specific expenses. You can categorize envelopes by expense, and each envelope contains enough cash to cover the cost of the cash outflow.
When you use a cash envelope system for personal finance management, you’ll often use actual cash and physical envelopes. Financial management tools, like budgeting software, have made it possible to practice the envelope budgeting but in a more secure, digital setting.
How does an envelope budgeting system work?
The budget envelope system works by helping you categorize your spending and set aside funds to pay for specific expenses. The process is relatively simple: As you earn money, you distribute it among your envelopes. Then, once the deadline for an expense arrives, you “spend” the cash from its envelope toward that cause.
For example, say you have an envelope for your insurance costs, where payment is due at the end of the month. You can save all month, putting aside funds into your insurance envelope. Then, at the end of the month, you remove the money from the envelope and make your payment.
In business applications, using digital tools to apply this technique is easier and more secure than physical envelopes.
Benefits of using a cash envelope budget to manage business cash flow
There are several benefits to using a cash envelope system for managing your business cash flow. Here are a few to consider:
- It gives you insight into your spending. Going through the process of categorizing your cash outflows can help you understand your business expenses better. This may help you identify expenses that you can cut back on, freeing up additional cash that you might spend elsewhere.
- Categorizing your expenses can streamline tax time. Using the envelope method can make it simpler to organize business expenses when it comes time to pay taxes. With budget envelopes, you’ll already have a record of how much you’ve spent on each business expense category over time.
- It’s highly visual. If you need help visualizing cash inflow and cash outflow, envelope budgeting is a good place to start. You can gain a clear idea of how quickly money moves, where it goes, and how often.
- It helps with budgeting expenses. In the hustle and bustle of business, it’s easy to overlook an upcoming bill. And it’s unfortunate when paying that bill means going cash flow negative. But envelope budgeting makes it easier to remember those regular expenses, especially when they’re labeled and organized by their due dates.
- It helps you save for emergencies. It can be difficult to set money aside for a rainy day when you have expenses to take care of right now. But labeling an envelope for emergencies and physically putting money aside every time cash comes in could help you build up that reserve. It’s all part of making sure the next unplanned expense doesn’t disrupt your larger cash flow strategy.
- It prevents overspending. If you typically use a credit card or debit card to pay for business expenses, it can be easy to overspend accidentally. Paying with cash gives you a finite amount to spend, helping you save money and stick to your monthly budget.
How to set up a budget system using envelopes
Set up an envelope budgeting system in seven easy steps:
- Categorize your business expenses.
- Balance your budget.
- Set spending limits for each category.
- Set up your envelopes.
- Separate your funds.
- Spend from your envelopes.
- Review and monitor your spending.
1. Categorize your business expenses
Before you can create envelopes and plan out how much money you need for each, you need to evaluate your spending habits. That means looking back on your business expenses for the last month or even year. Here are some of the most common categories to consider when recording your business expenses.
Budget categories for small businesses
- Rent or mortgage
- Utilities, internet, and phone
- Office supplies, including postage, paper, pens, printer ink, and office furniture
- Business expenses, including computer software and equipment, printers, fax machines, and phones
- Payroll expenses
- Employee benefits
- Business car payments
- Business travel
- Advertising and marketing expenses
- Professional services such as accounting and bookkeeping services, legal services, consultant and freelancer fees, etc.
Once you’ve recorded your expenses and sorted them into categories, separate them into chunks of time. Which expenses occur weekly, monthly, quarterly, or yearly?
From there, divvy up your fixed and variable expenses. Fixed expenses are payments “set in stone.” For instance, your business’s monthly rent or mortgage payment. Variable expenses are expenses that change, such as the amount you spend on business travel each month.
Take note of which expenses are most within your control. Taxes and business insurance, for instance, might be fixed or variable, but you don’t have an option to ignore them. On the other hand, your advertising budget can change from month to month, based on how much you want to invest.
Mark any expenses that are “nice to have” as opposed to “must pay.” These will be the first to go in the next step, should you not have enough cash for all your expenses.
2. Balance your budget
Once you know where your money is going, it’s time to balance the budget. In other words, you need to compare money out to money in.
Narrow down your budget to a window in time. Look at all the expenses you have in that window, then measure them against your income for that same period. If you don’t have enough money to cover your expenses, it’s time to make some changes.
Look through your record of expenses and remove any “nice to have” items you identified before. Next, get rid of any non-essential fixed expenses and reduce spending for controllable variable expenses. Hopefully, this brings your cash outflow and cash inflow back into alignment. If they’re not aligned, you may need to make some tough financial decisions to get back on track. Keep in mind that you can always increase your spending as your income grows.
3. Create spending categories and set limits for each
Now that you’ve removed any expenses that don’t fit into your budget, it’s time to set spending limits for each expense category. The idea is to allocate all of your income for that period between the different expense categories.
Set aside any non-controllable fixed expenses like rent or vehicle payments. In your budget, deduct any money needed for those envelopes from your income.
Next, use your recent research to set spending limits for your remaining categories. Anticipate how much you’ll need for each until you’ve distributed all your income for that period. If you can, create a category for saving money. Setting aside a little income each month in an emergency fund can help you navigate unplanned expenses.
4. Set up your envelopes
This step depends on whether your envelopes are tangible or virtual. You may also need to adapt these instructions based on your technology, should you decide to do your envelope budgeting digitally.
First, label your envelopes with the title of each expense category. Make a note of how much cash it needs and any hard deadlines.
Second, organize your envelopes. You may find it helpful to order them by their deadlines. If you categorize your most pressing due dates first, they’ll be harder to overlook. Fill those envelopes before the rest to make your payments on time. Envelopes with more flexible deadlines, or even deadlines you set yourself, might be the last to fill up in the month or period.
If you’re using paper envelopes, keep in mind some categories may record virtual cash deposits as well as physical. Especially if some of your income is in an online bank account. Record your digital cash savings alongside the physical cash deposits on the back of the envelope to avoid future confusion.
5. Separate your funds
As you collect income, distribute that cash among your envelopes. Record deposits as you add them to your envelopes to track your progress. Depending on each category’s deadline, you might put a little into each envelope every time you have money in hand. Or you might prefer to fill up envelopes one at a time.
There’s no right or wrong way to separate your funds. Though, it may take time to figure out which envelope categories work best for you.
6. Spend from your envelopes
Once you fill an envelope and payment is due, it’s time to “spend” from your envelope.
What comes next depends on your payment method. You might have to pay some bills online, for instance. In that case, you’ll need to make a bank deposit. You might have to pay others via check (another bank deposit) or cash.
If you have to run a payment through your checking account, be aware of things like transaction fees and lag times. If you have money sitting in an online account, consider putting those funds first toward envelopes with online expenses or payments. That way, you don’t have to deposit cash before you spend from that envelope.
7. Review and monitor your spending
The final step is to look back and check your progress. You might ask yourself the following questions:
- Were the financial goals you set for each expense category accurate?
- Did you have enough income to fill each envelope?
- Were there any unexpected expenses you’ll need to account for next time?
- Did you have any money left over?
Keep in mind that, like any new business strategy, envelope budgeting takes practice. The more you do it, the easier it gets. Variable expenses, for instance, are tough to estimate at first. But tracking your cash inflows and outflows may give you a more intimate understanding of the contributing factors. You may find yourself better anticipating those variable expenses as time goes on.
Using the envelope method with software and envelope budgeting apps
Small business owners can use financial software like QuickBooks Cash Flow, budgeting apps, or other solutions to practice envelope budgeting securely. And there are several benefits to doing so, beyond the general benefits of using budgeting envelopes. If you’re weighing your options between a cash system and digital envelopes, consider a few points.
- You’ll have a digital paper trail: Digital records are typically easier to save and search than physical paper trails. If you’re wondering how much money you put into a specific envelope four months ago, a digital solution can likely tell you in seconds. That can make it easier to build out your budget for next month.
- Your money may be more secure: Keeping large amounts of cash on hand isn’t a great idea, no matter how well you hide it. If you keep your money in the bank and then budget it digitally, you never have to worry about it being stolen or damaged.
- You can manage e-commerce easily: If your business takes a lot of digital payments, it may not make sense to use physical envelopes for budgeting. Instead, digital envelopes allow you to create envelopes while also viewing your business’s e-commerce activity and online bank account.
Envelope budgeting is a great strategy for tracking your business’s cash flow, especially if you’re a visual learner. In time, you’ll know more about where your money goes, how long it stays, and how much you need to accomplish your goals. It’s a worthwhile money management strategy for any small business owner who wants more insight into their business’s cash flow.