You know how the saying goes…”Cash is King.” Here’s the deal…”Cash Flow is King” when it comes to personal finance and building wealth. Cash flow can be defined as the net amount of cash or cash equivalents moving into and out your wallet. In fact, a critical aspect of financial planning for both a client and a potential financial adviser is to understand how much cash is flowing into the household. Maintaining a healthy cash flow is imperative, but can become difficult due to various circumstances and financial responsibilities (especially alter in life). As a result of the change, it is important for an individual to constantly track cash flow to maintain it.
One of the fundamental building blocks to building wealth is spending less than you earn. Make more than you spend and invest the difference wisely. Seems like a very simple concept doesn’t it? Even the building wealth concept is made simple due to technology advances and academic research. Then home come people don’t execute proper cash flow management?
People in their 20s can’t be bothered with how important money or cash flow management is
People in their 30s only focus on purchasing a home and starting a family
People in their 40s spend all of their money on children applicable expenses
People in their 50s it’s too late.
The key is to start early.
Personal cash flow is equivalent to the way money moves through your personal financial system. Understanding how your money flows into your bank accounts and then flows out towards either assets or liabilities (or misc. expenses). This sounds complicated or intimidating, but it isn’t. Read on.
Cash Flow Examined
As stated above, cash flow can be defined as the net amount of cash or cash equivalents moving into and out your wallet. But here is the simple arithmetic:
Total Income – Total Expenses = Net Cash Flow
Cash Flow can either be positive, negative, or zero.
Positive: Your income is higher than your expenses. As a result, you have a cash surplus. Maintaining and increasing your surplus is how rich people become rich.
Negative: Your income is lower than your expenses. Another way of saying it is that your expenses are higher than your income. You are spending too much money. As a result, you do not have a surplus. If you are serious about your personal finances, you need to fix this ASAP.
Zero: Your income is equal to your expenses. This is better than a negative cash flow, however efforts must be made to create a positive cash flow.
How to Improve Cash Flow
Tracking personal cash flow seems like a daunting task. After all, who wants to keep track of every single dollar that comes into and out of your bank accounts? However, there are magnificent personal finance tools available that automatically do this for you. By linking all of your accounts to a software tool, your cash flow is automatically computed and one can easily understand it. You can fully understand how much money is coming in and where it is going. You are also made aware of the sources if income and expenses. Personal capital is a great tool for this. I highly recommend it.
Reduce Expenses: This is actually the easy of the two ways to increase cash flow. The first think one should do to improve personal cash flow is to stop spending excess money on things you don’t need. At that point, evaluate your expenses and create a budget. Budgets are sexy. Budgets separate the lions from the sheep.
Increase Income: This is the hard part. It is actually hard to increase income. However, in order to do so you must be willing to make sacrifices. Think outside the box and increase the amount of money coming in.
To Improve Cash Flow, Think Like a CEO.
Control Costs: If you were a CEO of a company, would you be spending excess financial resources on waste or on items that do not provide a return? Of course not. So why should you! In fact, this blows my mind. People need to start treating their personal finances like a business. Then, miracles can happen.
Think Long Term: CEO’s think long term. They know that by saving excess financing they can improve shareholder return. With personal finances, you are the sole shareholder. By taking a surplus as a result of positive cash flow and investing you are setting yourself up for a wonderful financial future. The rich purchase assets that generate cash flow. They invest. You should too.
Know Your Personal Value: CEO’s know how important they are to publicly traded companies which is why they make absurd amounts of money. However, most of their compensation is in the form of equity and stock options. Why? Because the value of the shares are a direct result of company performance. Therefore, if the CEO is doing well, the shareholders are as well (usually). With personal finance, you are the CEO. You directly choose what to do with the money that comes into your bank account.
Why is it Important to Improve Cash Flow
Cash Flow is important for several reasons:
- Emergency Fund
- Tracking of Money
- Assists in Knowing how much you are saving: paying yourself first
- Can help in discovering how much is needed in retirement
- Disposable income
It can be said that cash flow is the blood line of any financial process. What to do with free cash (cash surplus) separates the boys from the men. It separates the rich from the poor.
Establishing healthy cash flow revolves around budgeting. It doesn’t matter if you make $38,000 / $72,000 / $400,000+, if your expenses surpass your income, you have a negative cash flow. For those striving to achieve financial independence, a negative cash flow will not get you there.