Today I’m talking about Cash Flow. It’s something that I’ve talked about in before. I think it’s one of the most important financial measures that you can do as an individual in terms of helping you advance within your wealth and your goals for retirement and for everyday living. Our financial plan is really centered around that cash flow. What I also want to talk about is how that cash flow influences other things, like your balance sheet.
So, first of all, what is cash flow? Very simply, it is your income minus your expenses. And hopefully that’s positive. But for some of you, it may be negative and for some of you, it may be negative and you may not necessarily realize that it’s negative and I’m going to show you why I think that could potentially be the case. Cash flow is obviously going to influence your balance sheet. Very simply, your balance sheet is going to be your assets minus your liabilities and that equals your net worth. So let’s think about this for a moment in the context of cash flow. If your cash flow is positive, that means that you can add money to your assets. You’re going to put money in your savings account, build up an emergency fund, cash reserves or maybe you’re putting money into a retirement plan like an IRA account or 401k plan at work. So if your cash flow is positive, you’re going to use up and build up assets.
If your cash flow is negative, one of two things is going to happen and this is why some people may not necessarily realize it’s happening. So if your cash flow is negative, if those expenses are more than your income coming in, that means you need to either sell some assets or maybe just simply write a check out of your savings account or direct deposit or direct debit from your account.
If we think for a moment about what our average monthly expenses are, we have things like utility bills, mortgage payments or insurance payments. And for many of us, we have a pretty good idea of what most of our month to month expenses are. We also probably have a pretty good idea of what our income is. Most of you watching this probably have a job or some kind of a regular stream of income. For some people it may be commission based or may get a lot of overtime or might be self employed so you might have more variability with income but most of us have a pretty good idea what your income is going to be.
When we look at this, we say we’ve got a certain amount of money coming in every month and we have a certain amount of expenses but if we think about our households that we operate, there’s a lot of expenses that may be extra things that don’t occur every month. Maybe things like a property taxes, one of those things that maybe comes up once or twice a year and is a very big bill. So we end up on this cash flow positive situation. We start building up some assets over here but then that property tax bill comes and now we’ve got take a bunch of money out of our savings account to cover that or we decide to remodel the kitchen or the bathroom and that’s probably not covered with your monthly cashflow that you have. It’s coming out of some assets or hopefully not but for some people, it may mean you’re racking up some liabilities. Maybe if your cash flow is off, you’re putting more money on credit cards or incurring more debt, you take on a second mortgage or whatever. So I think it’s important for us to be aware of how this cash flow influences things.
There are couple of different ways we can keep track of it. One way, of course, we can track our net worth over time to see what was our net worth at the beginning of the year versus the end of the year and how has that evolved over time and that would be an important thing to look at for sure but it may not give us a true representation, in fact it won’t give us a true representation of what is actually going on here with the cash flow situation because if you think about this for example, you could be adding more liabilities, you could be taking money out of your savings account.
I’m going to make this kinda messy here. Home value or your 401k balances or your other investments. If those investments are going up, you may not notice that as a net worth issues because those things are growing maybe faster than the rate that you’re adding liabilities or growing at a faster rate than you’re taking money out of your savings. So here’s a couple quick things that you can do.
Number one is, of course, you can start to track your expenses. And I think there’s two components to this. One component would be to make sure you understand what those regular monthly obligations are, the things that happen every single month and make some estimation. Of course you know that your heating bills, especially in Michigan will be higher in the winter time than it is in the summertime and your electric bill’s going to be higher in the summer with your air conditioner running. But try to normalize those things out, figure out about how much money you need for those regular monthly expenses, the groceries and all of that. Also, you want to be factoring in or thinking about what those big expenses are that you’re going to have throughout the year. Maybe it’s property taxes, you might have tuition bills for your kids or they’re in sports so you know that, hey, in September my kids are going to be back in soccer. I gotta write a check to the soccer club for that. You know, start making some estimations on what some of those other expenses are and even start to think ahead.
There’s a lot of things if you own a house, as you know and as I certainly know there are things that always need to be done. At my house, this is true actually. My house need to be painted outside so we’ve factored that in and said “Hey we’ve got a budget we’ve set aside that we have for “repainting some things on the outside of our house “so we can maintain that.” And you want to be doing those kind of things and home improvements are one of those things that could go up and down over time so you want to be thinking about what those expenses are over time. Tracking those expenses would be one of the most important things.
Another thing you can do too is try to keep things relatively simple. I’d like to operate primarily out of one checking account for our entire household and all of our bills flow out of that. All of our income goes into that checking account and so, we can track the balance of that account over time. So even if you kind of spot check it here and say “What was that balance at the beginning of the year?” And maybe check it every couple of months or so and what was it midyear, what was it at the end of the year… you can tell a lot from what happens to that checking account. So if the checking account had $20,000 balance at the beginning of the year but only had $10,000 at the end of the year, then you know that you’re taking out more cash flow than you have money coming in. There’s more money coming out of that account. Of course you want to also track the saving that you’re doing too. Maybe you did start the year with $20,000 and you finished the year at $10,000 or maybe you put $20,000 into your 401k plan at work, as an example. And so if that’s the case, now you’re actually if you look at this and you do the math, you’re actually $10,000 ahead on your cash flow. So those are the things that you want to understand and know the relationship of your cash flow versus your balance sheet and what is this doing to your net worth. Hopefully over time, especially while you’re working and you’re in the accumulation phase, you want this net worth to be going up.
You know, for many people, if you’re in retirement, you start to draw down some of your assets, it’s not uncommon, it’s not really a bad thing if your net worth start to go down a little bit. That’s why you saved the money. So you could do all the fun things that you want to do in retirement. But understand that relationship.
What I Do
I help individuals make the transition from working to retirement.
As you approach retirement you will be making some of the most important financial decisions of your life. Most of these decisions don’t get a do-over, once you’ve made them your stuck.
My goal is to help you get the most out of your retirement resources. I do this by coordinating and optimizing what I call the 7 Core Elements of Retirement Planning.
It all starts with a plan!
We use advanced financial planning software to help you understand your retirement cash flow so you know where the gaps are.
Understanding your retirement gap is the foundation to getting the most out out of your retirement resources and avoiding costly mistakes.