Personal Cash Flow and You

Let’s start out with defining exactly what “cash flow” means. It’s a business term that refers to the amount of money coming into and going out of a business over a period of time. In general, positive cash flow means that the amount of cash (and other things they might easily sell for cash without disrupting the business) on hand is increasing, while negative cash flow means that the amount of money on hand is decreasing.

For example, if a business pays all of its bills that month and still has $1,000 per month more in checking than where it started, it has a positive cash flow. If a business pays all of its bills and has $1,000 less in checking at the end of the month, it has a negative cash flow.

The same exact philosophy works with people, and it presents a very useful way to look at your personal finances.

Much like a business, you can simply create a cash flow statement each month or each quarter or each year to assess how much money is coming in, how much is going out, and how much is staying with you.

Let’s stop for a moment and look at what exactly a positive cash flow really means for a person. The larger your positive cash flow, the greater the difference between your income and spending over a given period of time. That means that, if you don’t make any changes to your life, you’re going to be accumulating wealth. It can also indicate the relative ease with which you can make life changes.

On the flip side, if you don’t have any positive cash flow at all or are seeing negative cash flow, it’s an indication that you’re on the road to financial ruin and need to make some changes, even if you haven’t seen any real problems pop up yet. A negative cash flow statement is a really good early warning sign for upcoming financial troubles and it can clearly alert you that some changes need to be made, particularly in terms of cutting spending.

My favorite use of personal cash flow is in making financial decisions.

For example, looking at a cash flow statement can help you determine whether a career change is something that makes sense or not. If you have a positive cash flow, that’s a sign that your current lifestyle can tolerate an income cut. If you’re considering a career change, that’s the type of information that can make a huge difference.

A cash flow statement can help you reprioritize your financial choices. Cash flow statements often point you toward taking action on things that will either decrease the amount of money you’re paying out each month or increasing the amount of money you’re taking in each month. Debt repayment becomes a big priority because that signifies the elimination of a bill once the debt is paid off. Career improvement can become a big priority, too. Cash flow statements often lead to action. Those types of decisions lead directly to an increased positive cash flow.

So, how do you prepare a personal cash flow statement?

Over the course of a month, simply keep track of all of the money you earn as well as all of the money that leaves your possession. How much were you paid? How much money did you pay out in the form of cash purchases and bill payments? That’s really what you’re concerned about – the end destination of every dollar you bring in. Did it wind up staying in one of your accounts (or in your wallet)? Or did it end up getting mailed out to a credit card holder or the mortgage holder or the electric company? Or did you use it to directly buy something?

That’s the simplest way to calculate your cash flow. I like to take it one step further. I count the purchases I make with a credit card against the current month. Then, when I actually pay a credit card bill, I only count the interest as money actually leaving my possession at that time. I counted the principal already when I counted the original purchase on the credit card. So, for example, if I buy a new shirt for $50 in August using a credit card, but then pay that credit card bill in September, I count that $50 as money going out. It takes some extra work – you have to read your credit card bill with some care – but it presents a much clearer picture of your true spending.

It’s useful to break down your spending into some categories when doing this. Make a big list of your various expenses, like utilities, food, entertainment, and so on. Where did all of that money go? That’s the point of a cash flow statement, and the more care you put into organizing that list of where all the money went, the better.

In the end, a cash flow statement might look something like this:

+$4,000 – Four paychecks, $1,000 each take home
-$400 – Utilities
-$800 – Food and household supplies
-$1,000 – Mortgage payment
-$300 – Car payment
-$200 – Car maintenance – gas, oil change, etc
-$300 – Insurance
-$300 – Entertainment – Netflix, cable, going out, hobbies
-$150 – Student loans
-$50 – Credit card interest
Total: +$500

That person managed to hold onto $500 that month. They have a positive cash flow, and that $500 is being put away for the future. Maybe it’s money being saved for a big upcoming expense, like a car replacement. Maybe it’s being put into a Roth IRA, or being put into an emergency fund. Whatever it is, this person is moving in a positive direction for the month.

However, if you do statements like this each month, it’s very likely that some months will have a negative cash flow. When a big bill comes in, it’s likely to cause you to tap some savings to be able to afford it, and that’s going to show up as a negative cash flow for the month. That’s why longer-term cash flow statements can also be useful, as they smooth out some of those bumps on the road and show you the broader picture.

So, what can you do with such a statement?

It can definitely show you areas in which to cut back your spending. Does this person really need to spend $300 in entertainment each month? Probably not. What about $800 in food and household supplies? Again, probably not.

It can help you set some good financial goals. This person might want to strive to have a neutral cash flow for a while in order to eliminate that $1,000 mortgage payment, by simply making extra mortgage payments. What that will do is eliminate the mortgage payment sooner rather than later, which will immediately turn that +$500 monthly cash flow into +$1,500. (It should be noted that a simple cash flow statement like this does put a high premium on paying off debts; it also doesn’t really inform you in terms of what to do with that positive cash flow, but that’s an entirely different can of worms.)

It can help you figure out whether major life changes can really work. If you have a +$500 cash flow in an average month, that means that you could make some major lifestyle changes without changing other things. You could switch to a less stressful job that brings home $500 less per month without making any lifestyle changes. If you made some smaller changes, you might be able to swing a full career change! Does a housing change make sense? Can you buy a house now with relatively minor lifestyle changes? This is the kind of thing that a cash flow statement can help with.

Having said that, a cash flow statement is just a tool, not a “be all end all” solution. It can help you figure out certain financial decisions and life choices. What it does not do is assess your overall financial health. It does not help you assess whether your investments are healthy. It does not clue you into your net worth. A net worth statement is good for that.

The more tools you have at your disposal for looking at your finances, the more likely it is that you’re going to arrive at financial and life decisions that make sense for you today as well as make sense for you in the long run. Remember, your goal is to improve your financial state so that the challenges of your future can be easily met, and your cash flow statement is one tool that can help you figure out that path.

Good luck!

The post Personal Cash Flow and You appeared first on The Simple Dollar.

Contributer : The Simple Dollar http://ift.tt/2wlArOx