Improving Your Personal Finances with Six Sigma

Where do you want to be financially one year from now?  You might want to eliminate some debt, or reach a savings level that will bring you more financial security, or both.  How well do you understand your earning and spending process, and how much potential does it have for improvement?  Six Sigma is a proven approach for analyzing and improving any repetitive process, and your “cash flow process” certainly falls into this category.

First Things First:  Do You Really Want to Improve?

First, a quick analogy.  There are a number of proven weight-loss plans in the world, and a lot of overweight people walking around.  Why is this?  In most cases, overweight people simply don’t want to lose weight badly enough.  They aren’t willing to follow a proven, disciplined process.  It’s that simple, and it’s okay – people have a right to eat what they want, as long as they are aware of the long term health consequences.  The same applies to personal finance:  if you are determined to make a difference, then read on.  Like all improvement efforts, this will require some work on your part, but the rewards will far outweigh the sacrifice.

Six Sigma – Where it Began and Why it Works

Six Sigma (visit the DMAICTools.com site for a complete overview) began at Motorola in the late 1980’s, and has since spread to virtually every industry that employs repetitive processes, be they manufacturing or transactional in nature.  The reason for Six Sigma’s popularity is its proven, five step approach referred to as DMAIC:  Define, Measure, Analyze, Improve, Control.  While other process improvement approaches yield incremental improvements, Six Sigma has a track record of delivering substantial cost savings and quality improvements wherever it is applied.

Applying the DMAIC Process to Personal Finance

There are two requirements for applying Six Sigma:  (1) the process being improved must be repeatable, meaning that it occurs the same way month-in and month-out, and (2) the process must have a measurable output that reflects success.  Our personal finances, and more specifically our “cash flow process,” easily fit these criteria.  Here are the steps:

Phase 1:  Define

In this phase we define the metric we will use to measure our financial performance on a monthly basis.  I recommend Free-and-Clear Cash (FACC) every month, which is total income minus total expenditures, before any money is put into savings.  In short, this is the month-over-month increase in your checking account balance, before any money is deposited so savings.

Phase 2:  Measure

You may have heard they saying, “what gets measured, gets improved.”  Six Sigma goes far beyond creating a metric and showing its trend, but we should never underestimate the power of simply recording our personal finance metric each month in a spreadsheet and observing the trend.  Back to Six Sigma, we must baseline our historical performance by gathering at least six months of our metric.  Take the average FACC value for the six months – this is our baseline.  Next, set an improvement goal.  I recommend a goal in the 10% to 20% range.

Phase 3:  Analyze

This phase involves the most work:  We analyze our spending with a tool known as the pareto chart, and categorize every expenditure for the last three months.  Start with gross income, so that federal, state, and local taxes are each noted in their own expense categories.  Group like expenses in a way that will show the most opportunity for improvement.  For example, rather than note items like “went to the movies” and “went out to eat” in separate categories,  group them into one category called “Entertainment.”

Phase 4:  Improve

Look at each bar on the Pareto Chart and challenge it:  how much could this bar be reduced with some creative thinking and/or discipline?  Look closely at the tax bars as well – are there things you can do to reduce taxes?  Leave no item unchallenged.  For example, I have a friend who recently realized that she was spending $65 a month at Starbucks.  Her solution was to cut her visits in half, and purchase some nice “to-go” cups for her home, so she could take her home-made coffee with her the of half of the time.

Come up with an action plan with the goal of implementing it fully within 30 days.  Just a quick note on this step:  most people who have not been through the Analyze and Improve phases find at least 10% worth of opportunity to improve their cash flow.

Phase 5:  Control

This phase is about sustaining what you have implemented.  As a first priority, set time aside in your monthly calendar to continue plotting your FACC metric.  Additionally, there may be some “fixes” that are behavioral related, like the Starbuck’s example above.  In these cases, track your spending levels and/or new behaviors in a  simple spreadsheet.

Wrap Up

In summary, if you are willing put some effort into the DMAIC process, you will likely see outstanding results over time, and will also have learned a valuable tool set for improving any process!