I’ve been using the “Envelope System” since January 2012. I can’t remember where I first heard about it, but I do know that a friend of mine started using the system before I did. Her recommendation is what made me decide to use it.
The envelope system works like this: at the beginning of the month, you take out a certain amount of cash and divide the cash among envelopes according to categories. Then, once the money in the envelope is gone, no more spending for the month in that category. The key with the categories is that you must determine them yourself. At first, I had a bunch of categories: groceries, dining out, medications, gifts, travel, haircuts, etc...the list goes on.
After a few months I had a pretty good idea of how well this was working for me, and what I realized is that I had to remember to bring envelopes with me all the time and it really became cumbersome. For example, if I decided I needed to stop and grab some milk on the way home and didn't have my “groceries” envelope with me, then either I couldn't buy the milk or I would have to use my debit or credit card, which negated the point of the envelope system.
So I devised a new system. I decided only to use the envelope system for groceries and happy hour/dining out expenses and that I would always keep these envelopes in my wallet. If I needed to buy something else on any given day I would use my credit card, having already transferred the money at the beginning of the month into the account from where I pay my credit card. I determined the budget beforehand, so I know exactly how much money I need each month for these expenses (such as gifts and haircuts). I may not use the money each month, but when I decide I need to buy a gift, I know I can charge it to my credit card because I've already allocated money towards this expense. I find that this benefits me in two ways: 1) I’m gaining points on my credit card and 2) with my budget already dictating a certain amount of money that goes into the credit card account, I have the money there to pay the card off every month.
The way I use the envelope system works for me because I keep track of what I spend and I budget for the month and for the year on certain items. It may work differently for others. Dave Ramsey has a basic tutorial on how to get your envelope system started, as do numerous other personal finance blogs. I hope my short explanation gives you insight on how you can modify the envelope system to work for you!