The rural economy in India heavily depends on rainfed agriculture that is severely affected by recurrent droughts. As a result, the financial management at household level undergoes drastic changes. This paper particularly attempts to reveal the nature of drought induced changes occurred to household financial management in drought prone Bolangir district of Western Orissa. The paper examines the drought induced changes in the pattern, sources and composition of income, expenditure and savings and highlights major income smoothing mechanisms adopted by different livelihood groups in the study area. The study reveals that recurrent drought has significantly impacted on a number of livelihood groups and has brought about major changes in composition of household income, expenditure and savings. Specifically, the share of crop farming in gross household income has significantly declined and that of non-farm activities has increased. In the drought year, not only income from agriculture fell drastically, the demand for labour also declined significantly. The income from livestock, artisan works, local businesses, labour works and forest resources contributed considerably to total household income, expenditure and savings in both normal and drought year. Crop insurance, non-farm activities like artisan works, sale and consumption of forest produces and informal borrowings were major income smoothing mechanisms for majority of livelihood groups. In order to reduce the level of fluctuations in financial position of vulnerable households, there is a need to bring more stability to agricultural income by increasing the area under assured irrigation by developing micro level water resources. Side by side, occupational diversification in rural area is required to be encouraged through proper policy instruments.