What Is Cash Flow and Is It Important?
By K. Bridget Schneider, CFP®, CRPC®
Cash flow is the movement of money into and out of your household. You will either have positive cash flow or negative cash flow depending on if you have more money coming in or more money going out. Negative cash flow creates a shortage in your budget. Understanding your cash flow and controlling it is an important step to financial responsibility. Regardless of their income, some people ignore this step and struggle to reach their financial goals. This is true even for people who are high earners since the more money they make, the more they ignore cash flow management. So, increasing your income doesn’t necessarily mean increasing your wealth. Let’s take a deeper look at cash flow and why it is important.
Prepare a Cash Flow Statement
You may have money coming in from a job, dividends or interest on investments, or payments owed to you by others. The money going out of your household may be for housing, utilities, food, payments you owe others, or other ways you choose to spend it. Don’t forget to include the expenses that only occur occasionally or once a year like vacations and holiday spending. Here is a free Budget Worksheet that can help you get started.
Where Did the Money Go?
Cash flow statements can show you where money is going and help you decide where you might decrease the amount you’re paying out. Just becoming aware of spending can often help you increase your savings. You might find gym memberships or magazine, car wash, or cable subscriptions that you haven’t used in months. You may think you’re spending about $300/month eating out but find that you’re really spending an average of $1,000 each month.
Paying off debt may become a priority so that once it is paid off, positive cash flow will increase. You may decide to drive your car a little longer rather than financing the cost of a new one. Or you might choose to increase the money coming into the household. You may decide to pursue a second income or even choose another profession. Those types of decisions can lead to an increased positive cash flow. Deciding to attain a positive cash flow is useful to help pursue your financial goals.
Focus on Positive Cash Flow
Ideally, you want to try for a positive cash flow of at least 20 – 30% of your income so you can apply it to your retirement savings, a vacation home, or add to your emergency fund. I suggest that you make cash flow a priority so that it comes off the top before you spend each month. But most people don’t start there. Instead of spending first and saving the rest, you’ll want to save first and then use the rest to meet expenses.
Your spending will change over time and you shouldn’t be too rigid here. Why? Because life will throw you a curve occasionally, and your plans will need to adjust along with it. You should review your planned spending and goals from time to time. If you discover expenses that you incurred in the past but are no longer a priority to you or don’t fit with your values, reduce your amount in that area. For example, if you realize that you spent a lot on snacks that don’t fit your health priorities, you can adjust that category to allocate that money elsewhere or eliminate that spending altogether.
Your goal is to slowly increase your monthly cash flow. Find small areas to make changes. Challenge yourself to reduce some of your discretionary spending by 5 – 10% in the future. You may want to enlist the help of a CFP® Professional to help evaluate your spending and increase your positive cash flow.
Putting It All Together
Cash flow can provide the key to financial responsibility. It may be the difference between future happiness and future misery. Decisions made today can impact us long after we’ve forgotten what we did that year. Deficits now could create financial emergencies in the future, but years of positive cash flow can provide smooth sailing for the unknowns in your future. It’s all about cash flow.
Choose the goal of knowing how you spend your money rather than spending everything you earn. If you are looking for a place to start or have questions that need answering, then be sure to visit our website today, call us at 217-605-8130, or click here to schedule a free, no-obligation consultation. As your friendly financial guide and ally, we can help you develop a financial plan, review your investment strategy, or structure a retirement plan that makes sense for your unique situation.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual, nor intended to be a substitute for specific individualized tax or legal advice.
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