Have you heard of Cash Flow? If you’re in business leadership or real estate, you have probably heard the term tossed around. However, it is a principle that does wonders for both business and individual finance. If you want to get your personal finance in shape and start building wealth, you really need to get your cash flow in check.
Cash flow is fundamental to all topics related to personal finance. If I could use one metric to determine if someone has a healthy financial direction, it is cash flow. Some would say net worth is the best way to tell someone’s financial situation, however I argue that there are so many examples of people who were worth millions but lost it all due to poor money management that could have been fixed if they focused on their cash flow.
Net worth is an important metric to know about your personal finance, and you need a certain amount to become financially independent, but net worth will follow cash flow naturally.
Below you can see a picture of my cash flow as reported by Personal Capital. This is from working my 9-5 and it consists of regular income, no special bonuses and only minor income from other sources. Note in August I purchased a vehicle, so Personal Capital tracked that as an cash outflow in that month, but we’ll talk about cash outflows later along with the story of my vehicle purchase.
How to Calculate Your Cash Flow Statement
Cash Flow = Cash Inflows (income) – Cash Outflows (expenses)
Calculating cash flow is as simple as listing out all of your inflows and outflows and subtracting accordingly. Cash inflows are how much cash you’re bringing in. Here’s some items that might be considered cash inflow:
- Job Income
- Stock Dividends
- Annuity Payments
- Real Estate Income
- Other income streams
These are all liquid streams of income that you can utilize immediately. Note that cash inflows do not include increases in equity or stock value, unless the equity is is somehow being converted to cash on a monthly basis.
It does not include 401k investment growth because you cannot utilize that money without penalty and most 401k dividends are automatically reinvested into equity.
Cash outflows are essentially monthly expenses. They include all of the following:
- Mortgage or Rent Payments
- Insurance Premiums
- Healthcare Costs
- Vehicle Costs
- Entertainment, Restaurants, Clothes, Electronics, and Toys.
Even your random regular purchases fall under the cash outflow column. I would not necessarily include when you purchase new assets as cash outflows, because the cash is flowing to yourself not “out”. So when purchasing a car with cash you would not count your entire car purchase as outflow, only the depreciation from driving it off the lot.
When calculating cash flow, I’d recommend simplifying it as much as possible. Instead of putting your entire income on one side of the equation and your taxes on the other, simply use your after-tax income as cash inflow. If you want to make yourself a nice official cash flow statement, you will probably want to be more specific, but for most purposes you are fine simplifying!
One of the benefits of calculating your cash flow is that you can then make yourself a budget. You simply look at what your current cash outflows are for the previous month, and adjust each item to where you think you should spend next month. That’s your budget!
Automatically Track Cash Flow
You need to focus on the equation and fashion a budget from it. So before you automate your cash flow tracking, first write it down or build a spreadsheet. Once you have a feel for your finances, I would automate the tracking.
It is a free tool that is compatible with many financial accounts and calculates your cash flow for you. It breaks down your income and spending into categories so you know the components of your cash flow. I use it every day to look at all my expenses in one place and see how my investments are doing, but use it monthly to see where my cash flow is.
Beyond cash flow, I use it to track my net worth because it connects with mortgage accounts and home values. It provides a lot of insight into my investment accounts, even my work retirement account.
As you saw earlier one of the downsides is that it counts your vehicle purchase as a normal expense on cash flow rather than an asset acquisition. However, I added my vehicle as an asset in my account so my net worth didn’t take a huge “hit” from the car purchase.
Dangers of a Low Cash Flow
Low or negative cash flow is dangerous. It usually means your net worth is not increasing, but is always means you are not flexible enough for whatever life brings your way.
Let’s say Bob earns $5k a month, but every month he spends all $5k. He make a $2k house payment, pay $1k in debt repayments, and always seems to buy new gadgets, clothes, and go out to eat. Somehow Bob ends up with only a few dollars each month but it has never driven him to action. His cash flow is $0 a month.
Beyond the fact that Bob’s net worth isn’t increasing, he is not ready for an emergency. One day Bob’s car breaks down and he has to fix it on a credit card. Now he’s carrying more debt with high payments, and has to cut back expenses to make those payments.
Now Katie is also making $5k a month. But she lives with frugality, has a $1k mortgage payment, paid off her other debt last year, and only spends $2k more. Her cash flow is $2k a month. She can do what she wants with that $2k, whether build an emergency fund, invest it, or give it to charity.
Katie’s car breaks down, and she uses a small chunk of her emergency fund to pay for it. Within one month, she has her emergency fund built back up, and she’s back to having a free $2k to play with.
So you can see that cash flow can make or break a financial situation. Remember earlier when I claimed people have had million dollar net worths but lost it all because their cash flow was not healthy? Consider the story of Dave Ramsey himself. He went into real estate at an early age and took on about $3-$4 million in debt to buy buildings. So the amount of equity he owned increased to a little over $1 million by the time he was 26. However when your debt payments start to overtake your cash inflows, you start to really dig yourself into a hole. Ramsey basically had to start over with a negative net worth at one point!
Ways to Improve Your Cash Flow
By now you know what I will recommend, and you are correct, you need to spend less. You need to get rid of those high debt payments and live within your means. Focus on the things that matter, not the things that are expensive and habitual.
Just about everybody spends a lot more on things we don’t need than we think we do. I have self-control issues, you have self-control issues, your neighbor down the street has self-control issues. It is human nature to have self-control issues. We are wired to acquire things and our addictive chemicals are triggered when we swipe cards and acquire new property.
Bad spending habits are nothing extraordinary, but nonetheless they are unacceptable going forward if you want to decrease your outflows and improve your financial situation.
As I stated earlier, once you get that cash flow statement created you can simply look at your spending and set goals. List out all of the categories you spend on. Do you eat at restaurants a lot? Are you a sucker for Starbucks? How many random items do you order from Amazon? Unless you have already intentionally cut out all of that stuff, you probably have more money than you realize tied up in those non-essential categories.
Once you’ve written down those goals, you have a budget. A budget is a fundamental tool that, if followed, keeps your cash outflows in check. Instead of spending $1,000 a month on restaurants and bars, set a goal of $75 a month or less. Next time you purchase a car, make sure it is one that’ll cost you a minimal amount, not $500 a month payments. Never say you deserve something, and therefore have to purchase it. You are stronger than that, and can find your joy in friendships and family rather than objects.
The other half of the equation is much more interesting, you need to earn more money to improve your cash flow. For a most people they can’t snap their fingers and have more money overnight. Instead, it takes a long time to build stream of income. It is difficult and takes quite a bit of work to build additional streams of income but can be quite worth it in the long run. Some forms of other streams of income might be acquiring small businesses, building music and book royalties, or building websites.
I made a goal to wake up an hour earlier each morning before work to work on EarnTrackInvest. That’s one way to squeeze in extra work to try to create an income-producing property. The goal here isn’t to make quick money, but to build a brand that helps people with their finances and as a result turns into a valuable income producer in the long run. You might want to dedicate an hour a day to your side-hustle as well. Just about any hobby or passion can be turned into a side-hustle. We will discuss more on this site how you can turn any passion into a side-hustle later, it will be a large focus of our invest section of the site.
Meanwhile, the career path you’re on may be your occupational goal in life. If so, renew your focus and speed up that path. Always pick up new, marketable skills and put in as much work as possible to speed up down that path.
If you have some time on the weekends or evenings, one option to make some money is to drive for Uber or Lyft. It is easier than you think to drive for them, and not near as scary as some make it out to be. It could be as simple as helping someone get from the airport to their hotel, or perhaps from their home to their job. You probably won’t run into too many issues unless you’re transporting people from bars or sporting events, and even then issues are rare.
Cash Flow in Retirement
Retirement is essentially the ability to live off your cash flows without the need for a full-time career. To do that, you need to make sure you have a healthy cash flow right now and invest a large part of it. Later your investment inflows need to be greater than the amount you have to spend in retirement.
A lot of retirement equations are based on how much you can spend and not run out of money before you die. But there are problems with that line of thinking. First, what if you live to an extraordinarily old age? Second, it is preferable for most people to leave a legacy for their children or favorite charitable causes.
But if your cash flow is positive on average per year in retirement, your nest egg will not diminish and may even grow. So keep those outflows within your means, and make sure your investments are copious and smart.
If you’re young, commit to putting quite a bit into investing so you can live big in retirement. By the time you retire you’ll want to have $0 in debt payments to reduce expenses and stay flexible. If you are already retired without a big portfolio, you can still work on both sides of the equation to some extent.
By definition, you aren’t working 9-5, but don’t let that stop you from making money off of a hobby. If you have a passion, you may be able to earn from it.
But also cut down on unnecessary expenses and focus on the things that matter the most in life.
Real Estate Cash Flow
Nobody will claim I’m a real estate expert. In fact, I have ZERO experience beyond buying my own house in the real estate market.
But you hear the term cash flow in real estate all the time. I find it important to use real estate as an example of why cash flow is so important.
Let’s make an example of someone who is super leveraged. Leverage is using debt to increase your exposure to the market. In real estate, leverage means you make mortgage payments. I am personally leveraged on my house because I have a mortgage.
In this example you own a 10 unit building, and you have 9 tenants each paying $750 rent for a total of $6750. Your mortgage each month is $6000 and you’re happy because you have $750 real estate cash flow. To top it off, you gain equity in your property because your tenants pay the mortgage.
But as always, the market is cyclical and one day you find yourself with 6 tenants and much lower equity. Your cash flow is now negative $1,500 and you’re desperate to find new tenants or offload the property. Some savvy investor comes along and you sell the building at a loss.
It is crucial in real estate investing that your cash flow is flexible enough to cover the market swings. Your cash flow needs to be better than the worst case scenario. I’m not saying to avoid all leverage, but have enough cash flow to cover those low occupancy seasons.
I hope you now consider cash flow an important area of your finances. If you don’t currently track it, I urge you to with Personal Capital. It may seem like a boring or nerdy thing to do right now, but it will help a lot.
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