It doesn’t matter how you live. It doesn’t matter what car you drive. It doesn’t matter what kind of clothes you wear. The more you stress over bills, the more difficult it is to focus on your goals. The cheaper you can live, the greater your options.
– Mark Cuban
Most people think they understand this concept, but defining it in words is a little more difficult. So, would you be able to explain clearly what cash flow is? What keywords are fundamental in its definition? What is its main function? And, logically, how is it important to our economy? We’re not very sure about that – so let’s see.
The simplest way of defining cash flow is as follows: the net sum of cash, both incoming and outgoing, which affects your finances for a given period of time.
It may seem like just one more parameter, but it is an essential indicator of economic solvency and an individual’s ability to take on debt or unforeseen circumstances. The set of information it gives us will tell us if our accounts are healthy or if changes need to be made in order to improve our financial situation.
The most common thing to do is a monthly budget, which will give you very relevant information regarding your finances. You can see if they are stable, or if there are many ups and downs in the net flow each month. These can be an indicator of compulsive buying. If you are a compulsive buyer, you will see that over the course of the months you have occasional expenses reducing your cash flow, and even perhaps taking it into the negative. Doing this exercise will help you realize the importance of reducing those occasional costs that are weighing you down.
A great option for achieving the stability you want consists of dividing any annual payments into monthly ones (as long as there’s no fee for doing so), which makes it much easier to have real control over your net balance each month.
Categorizing cash flow
The information given by your finances will show one of two basic results:
Positive cash flow. This means that little by little, your coffers are increasing. This happens because your net balance each month is positive. It may not be the case every single month, but in general, it will be. Thanks to this positive flow you can pay off debts, save for rainy-day funds or invest to get income later.
Negative cash flow. This means a hole in your pocket somewhere: your cash is depleting! Bad sign. Negative flow happens when your spending is greater than your income, giving you a negative net balance. If this is due to something temporary such as a controlled investment, it may not be so bad, but if your cash flow is negative overall then you’re going wrong somewhere. Try to find new sources of income, check on spending to reduce it, and apply saving methods such as those we have already looked at to try to turn the situation around.
Another, less common but equally valid, way to categorize cash flow is based on the purpose we are assigning to that cash: the ends they are used for.
Operational flow. Expenses or income derived from everyday activity. Normal costs such as buying groceries or paying utility bills.
Investment flow. This refers to costs and income aimed at generating profit. For example, buying property in order to rent it out, or spending on training or education.
Financial flow. This is the movement of cash related to financial activity, such as paying off a loan.
Now, let’s look at an example table containing Adri’s information, which could belong to many middle-class people.
The great thing about tablets is that they enable you to see a lot of information at a glance. Below, we’ll analyze the results of this table.
The monthly flow is shown in the “net balance each month” row. As you can see, it fluctuates a lot. If you look at the different rows, you’ll see that in this example it mostly depends on two variables: leisure and bills. The rest of the income and expenditure is largely stable.
For bills to vary this much could be down to several factors. We advise you to do a month-by-month breakdown so that the figure
for each month will fluctuate less.
The other variable, leisure, go up and down a little in line with other costs and with possible key dates such as Christmas, Easter, or other celebrations that make it suddenly shoot up.
As such, if you break down your bills and limit leisure spending without leaning on other costs, you can manage to save and achieve a positive flow every month.
Cumulative flow is shown in the net cumulative balance row. In this case, we can see that even as the months go on, there is a point at which cumulative flow is negative. This should not occur. There can normally be a positive monthly flow, with a negative flow one month due to exceptional circumstances, but if we are looking after things in other months then the cumulative balance should never dip below zero.
The best way to guarantee a positive monthly flow is to pay yourself first, an amount you deem suitable. Add a row with the monthly savings you can accrue. This way, you guarantee you’ll reduce your unnecessary costs and improve your finances.
To sum up, in order to achieve a positive cash flow you should follow a series of guidelines that will offer you stability. This will help you better control your spending and manage to put a little money aside each month.
Get to it!
ANALYZE YOUR CASH FLOW
Gather data for your income and spending over the past six months and analyze it in a table like the one we just used to analyze your monthly cash flow and the flow accumulated over that time. Is your monthly cash flow stable? Have you managed to save over the course of the months? This is a simple and effective way to explore the state of your finances.
We added a row for the monthly savings you decide to put aside. This will really help you to achieve a consistent positive cash flow.
- Draw up a budget with your monthly income and spending. In it, detail the different types of income and costs you have and categorize them as we have seen in previous chapters. This way, you’ll know you’re not missing anything.
- Add a row for your monthly savings and remember to pay yourself first. This will help you avoid expenses piling up: something that will stop you from being able to save at the end of the month.
- Divide any annual bills you have into monthly payments. As long as this is possible and won’t incur any fees. It will help you achieve stability month to month.
- Gradually apply the spending-reduction methods we’ve looked at. You’ll be able to save more every month and your cumulative cash flow will continue to go up.