What is Cash Flow and Why I believe it is more important than Cash.
Cash is King! Or is it?
You probably have heard this term at some point and at first glace it seems to make sense. What I have come to realize after helping people with their money since 2006 is that Cash Flow is more important than Cash.
I have found that understanding:
- What cash flow is
- Why it’s important
- And what your particular cash flow looks like
Helps you learn one of the most important financial concepts you can ever know, Cash Flow. Yes, it makes sense to know things about investing, insurance, taxes, etc. But Cash Flow makes doing pretty much anything you want to do in life or business possible.
Knowing your cash flow can mean the difference between financial freedom and financial ruin, which one do you want?
What Is Cash Flow?
In a nutshell, cash flow is the flow (amount) of money coming in and going out of your bank account. Think of it as a water tank: water comes in at the top and drains out the bottom. In order to keep your tank full, you want more coming in than going out. If only it were that easy though!
Here is a simple cash flow example:
- Monthly take home pay of $5,000.00 – This is cash flow in
- Monthly expenses (mortgage, rent, car, food, etc.) $4,000.00 – This is cash flow out
- Net monthly cash flow is $500.00 – This is positive (net) cash flow – Which is what you want!!
Now this example is oversimplified to illustrate the basics of cash flow. It can and does get more complicated depending on your income sources, expenses, and so forth, but ultimately you still end up with more, or less, cash in your bank account each month.
Cash Flow Inflow
Cash inflow is what you use to pay for everything you, your family, or business needs each month. It comes from sources like your pay check, payments from customers, investment or rental income, interest on savings, or things like pensions and income annuities.
Positive cash flow is very important for a number of reasons, but I would argue the most important reason is that it allows you to take your positive cash flow each month and reinvest it back into the sources of income that are generating them or diversify and invest it in alternate sources of income.
On the flip side, there’s negative cash flow – such as: more money flowing out than money coming in.
Cash Flow Outflow
Cash outflow is normal, unless you have absolutely no expenses. Is that even possible?!
Cash outflow is a result of your ongoing normal and one-off expenses (expected and unexpected). We need to pay for things to live the lifestyle we have chosen and/or to run our business. The key is knowing the difference between your cash flow inand cash flow out. If you don’t the results can be financially catastrophic!
It is my opinion that so many Americans are in debt because they don’t understand the basics of cash flow planning. They have a “gut feeling” that they have enough cash but in reality, many people have very little idea of their actual cash flow.
I have worked with over 1000 people in my 14 years and although I don’t have an exact figure, I would be willing to bet that only 1 in 9 actually have a good handle on their cash flow when we start working together. It is a scary number, but can you really blame people? Money as a subject is not formally taught to us, so how are we supposed to know about Cash Flow Management when we were never told about it in the first place!?
Get Organized and Plan your Cash Flow
Failing to plan is planning to fail.
Positive cash flow is driven by two things: organization and planning. As simple as that!
Start with a pen and paper and just write down all your monthly incomes and expenses. Add it up and see if you have more coming in or more going out. It is a quick and dirty exercise to establish a baseline of where your cash flow currently is.
Now it’s time to take this cash flow bull by the horn!
Be honest with yourself, is your cash flow worse than you thought it was? You must be open and honest with yourself, and spouse if you have shared finances, in order to make some positive adjustments. Do you really need that $5 latte on the way to work every morning? Do you really need 5 different streaming video services? Although these things bring us little joys each day, they end up bringing us down in the long run.
Do you ever feel like you are in a hamster wheel? Why can you never seem to get ahead? It’s highly likely because you don’t have a solid grasp on the money you are spending.
So, assess your monthly expenses. This can be a bit difficult because it’s easy to overlook things only to end up with a surprise you really didn’t anticipate. But all it really takes is a little bit of time logging into your bank accounts and credit cards to see what your monthly expenses are. Here are some of the basics to look for:
- rent or mortgage
- car payment
- insurance (life, disability, car, home, liability, etc.)
- Streaming services
- Taxes – if you are a W2 employee this is easy to figure out, but still important to know
- Personal loan payments
- Haircuts, spa, etc.
- Going out for dinner and drinks
Remember to be honest and objective when looking at your cash flow expenditures. I have found a lot of people initially put off doing this exercise since they are worried what they might find. The funny thing is, even if they have negative cash flow, is that once they know the real numbers, they can now do something about it!
Taking this cash flow bull by the horns and showing it who is boss will give you a feeling of relief. All it takes is action once you know your cash flow situation, you can make changes today, right now, that will help you feel better about what your near- and long-term financial future looks like.
So, Why is Cash Flow more important than Cash?
Yes, cash in the bank, or even under your mattress, is important and has its place. But it’s been my experience that the cash flow produced from your investments (401k, 403b, IRA, Roth IRA, Investment Account, etc.) is more important because the cash flow produced is what we actually use.
I manage money in various account types for my clients. Very rarely do they call and say “Derek, you rock but I need to close my account and buy XYZ with it.” Although this does happen on occasion most people want to know how much income (cash flow inflow) their accounts will produce so they know what kind of income they can expect to receive on a regular basis.
Don’t get me wrong, cash (in various forms) is still important, but what I have seen is that people are more concerned about what that cash is doing for them, or could do, from an income perspective. Because at the end of the day people need the cash flow income to pay for their lifestyle, simple as that.
Cash Flow Management
One of the things I help my clients with is to do a deep dive into their cash flow to help them figure out:
- What it is
- What changes they may want to make
- How to leverage their positive cash flow to do more of the things they want in life.
The process is simply liberating!
We even use a really cool cash flow tool as part of the eMoney dashboard I provide my clients. It looks at cash flow based off the connected data and can be set up to benchmark against a monthly budget. This way you can see at any time what you are spending and if you are on track based upon the budget we set up.
If you are looking to figure out or improve your cash flow, then I encourage you to get in touch with a professional to have an initial conversation about your plans for the future. Putting a financial plan in place to address and solve your varied problems can ensure peace of mind and financial security.
Thank you for reading!