Almost all businesses go bankrupt because they run out of cash flow to service their operations. Cash flow management is crucial for businesses and should be for managing personal finances as well. However, a lot of people are confused by the concept of cash flow. This article goes over the concept of cash flow and its importance in the budgeting process.
What is cash flow and why is it important? How is it different from simply income minus expense?
Cash flow is what is left after you subtract cash inflow from cash outflows. It’s the cash that you actually spend. How is this different from your savings (net income minus total expenses)? Well, if you put a part of your expenses on credit cards, or use “Buy Now, Pay Later”, then your monthly cash flow is likely different from your savings. For example, if you earn $1,000 a month and spend $800 a month, and put $500 (of the $800) in credit cards, you might see a cash flow of $700, when in reality your savings is only $200. This type of mismanagement of personal cash flow is why a lot of people end up cutting up their credit cards. The below illustrates the concept above:
Why managing personal cash flow is imperative to the budgeting process
If you fail to pay attention to cash flow, it could create the illusion that your expenses are lower than what they actually are (i.e. using a credit card can make cash flow positive because you are delaying cash outflow). Back to our example above, thinking that you have $700 remaining when you only have $200 can lead to excessive spending. In other words, failing to recognize $500 of credit card debt can make you feel like there’s excess cash flow and be much more liberal in one time purchases. For example, you might spend another $250 and think you have $450 remaining, when in actuality you would be in the negative after paying off credit card debt.
Below is an example illustrating the concept discussed above:
Remember, very few, if any, can 100% stick to a budget. One time expenses always come up. Recognizing your cash flow will help you to keep your expenses in line and end up net positive 100% of the time.
Tips to keep track of and make the most out of personal cash flow
Here are some tips to keep track of and achieve positive personal cash flow:
- Before anything else, you have to have a budget. You can either use a simple spreadsheet or there are also a lot of apps to help you keep track of your budgeting.
- Keeping track of your outstanding credit card expenses and installment payments. When you are calculating your savings, remember to subtract all your outstanding credit card debt and your total installment payments. The remaining amount is your savings.
- Keep track of your one time expenses. One time expenses can be OK as long as recurring expenses are consistently lower than cash inflow. It’s worth noting that if you routinely make “one time” purchases then it’s no longer a one time expense. For example, if you drink a cup of starbucks once in a while, it’s a one time expense. If you drink one everyday, then it’s a recurring expense.
- Finally, always try to keep your cash flow positive. Remember, if you don’t pay off your credit card in full every month or make installment purchases, your positive cash flow might not necessarily equate to savings. That being said, if your cash flow is already negative even before accounting for credit card debt and installments payments, you will be in a very tough spot. One of the best ways to achieve positive cash flow is to keep your monthly recurring expenses low. Some recurring expenses such as rent and utilities are a necessity, but others such as subscriptions or lease payments for a second car, are optional. It’s definitely OK to have optional recurring expenses as long as you make sure they don’t exceed your monthly cash flow.
Keeping track of your personal cash flow can help you consistently save when all is said and done. Having savings consistently will allow you to grow your net worth through investing. If you need some help brainstorming for investing ideas, please refer to this post.