today is the only cash you have - so spend it wisely."
- Kay Lyons
The proper handling of cash in your budget may seem a little confusing as first, but with a few simple rules, cash items can be handled in a straightforward manner and treated like all other items.
Create a cash account with your budgeting software. Unless you pay for almost everything by check or credit, it's generally a mistake not to create a cash account. Even though we prefer to use as little cash as possible, I'm always surprised at how much cash we actually use. It usually totals around $2,000 each year. Some people are uncomfortable creating a cash account because it's not a "real" account with an account number from a financial institution. Keep in mind that an account can be any logical grouping of assets or liabilities that help you organize and track things. An account doesn't have to involve a statement from a financial institution.
Record ATM withdrawals as transfers to your cash account. Your ATM withdrawals are simply entered as transfers from your checking or savings account to your cash account. If you withdraw money by cashing checks from your own checking account made out to "CASH", then that is handled the same way. There is no spending category associated with an ATM withdrawal because you haven't spent the money on anything yet. It's only a transfer at that point.
Save and record your cash receipts in your cash account. Your cash receipts are entered in the register of your cash account, and you categorize each cash spending receipt just like you would any other kind of spending receipt. This makes it very easy to enter the receipts.
Balance your cash account periodically. Another reason some people don't like cash accounts is that there is no monthly statement to balance. Since there is no statement to remind you how you spent your cash, it's often the case that you can't account for quite a bit of it. Sometimes you lose cash receipts, and sometimes you never get them in the first place. I've heard people complain that they really hate to use a cash account because they never have on hand the amount of cash stated in their account. Over time this divergence grows and can be really misleading. This situation is caused by not balancing the account, which is something you should do periodically. I balance our cash account at the end of every month. All I do is add up how much cash we have lying around at the end of the month and update the cash account balance to that amount. The reconciling transaction is categorized as "not categorized" in our budget. There are some people who get squeamish about this sort of approach because it seems like a hack and not the way to properly balance an account. However, when you update a cash account in this way, it does reflect reality. Based on the best information you have, the value of your cash account is now correct, and the amount that was missing should in fact be assigned to some sort of category such as "uncategorized" or "not categorized".
It's possible to track cash expenses without a cash account. In my early years of using Quicken, I actually tracked cash expenses by recording everything inside of ATM withdrawal transactions. This kind of system does work to some extent, but it wastes a lot of your time. Every time you need to enter a cash expense, you have to hunt down an ATM withdrawal that you previously entered as "uncategorized" and then update it to reflect the categorized expense. You often have to split up a single ATM withdrawal into many categories and amounts and you have to keep adjusting the "uncategorized" portion to keep things balanced. You also have to record your spending on the date of the withdrawal, which can be confusing unless the cash was actually spent the same day as the withdrawal. If your cash comes from several checking accounts, you may have to hunt around to find an appropriate withdrawal transaction. All of these steps are horribly inefficient.
It is much easier and faster to use a cash account. If you're not tracking cash expenses at all, a cash account will help you efficiently track those expenses. If you're already tracking your cash expenses, but you're not using a cash account, then creating and using a cash account will probably save you a lot of time and frustration. I would encourage you to start using one soon.