Last week we learned that building net worth is a top goal for your personal finances. How do you accumulate net worth? Since net worth relies on assets, the key to growing net worth is to grow assets. Assets like investments help because they grow in value, but what if your investments take a downturn? Then the only way to grow your assets is to add more money. For that reason and to make investment purchases to begin with, you need cash flow. What is cash flow?
Cash Flow = Income (-) Expenses
Income accounts for all money coming in, hence “in” “come.” This could be anything from working wages to monetary gifts to investment growth (take bank interest, for example).
Expenses take money out of your wallet. If you need to pay for it, and it does not go back in your wallet, then it’s an expense. Rent, groceries, shopping, pet care are just a few examples. If you calculate cash flow on a monthly basis, remember to include any annual income (such as a bonus) and annual expenses as a monthly amount.
Cash Flow Sample Calculation
Monthly Income ($3,200):
- $3,200 Paycheck (gross or before taxes and deductions)
Monthly Expenses ($2,800):
- $1,500 Rent
- $ 500 Taxes
- $ 200 Car Loan Payments
- $ 200 Groceries
- $ 150 Health Care Insurance and Medical Costs
- $ 150 Auto (Gas, Maintenance, Vehicle Registration)
- $ 100 Personal Spending
Monthly Cash Flow = Income (-) Expenses = $3,200-$2,800 = $400
Positive or Negative?
As with net worth, the key to cash flow is to stay positive! Limit expenses to no more than your income in order to live within your means. Not living within your means will require borrowing money, which ends up costing more (sometimes much more) than the paid price. And paying back debt eats away at your income too. So if you encounter negative cash flow, consider lowering expenses or increasing income to get to a positive cash flow.
For those with positive cash flow, the remaining amount is probably used for savings, right? But are there enough savings to reach your goals? Rather than looking at cash flow as available savings, consider subtracting savings along with necessary expenses, and then treat what’s leftover as your spending allowance. Here’s a better equation to follow:
Discretionary Spending = Income (-) Savings (-) Necessary Expenses
Net worth combined with cash flow are a great starting point if you’re figuring out where you stand financially. Anyone can be a financial ace with a bit of math and some money!
Homework: Calculate your cash flow. Is there anything you need to adjust? How are you doing on savings and expenses?
Winter Break: Ace Academy will skip the next two weeks’ lessons and be back in session during the first full week of January. Happy Holidays to all!