YOUR WAY TO WEALTH, IS CASH FLOW

So what is cash flow and why should you be interested?  Cash flow is how your money comes into your household and then how it either stays or flows out.  People who become wealthy find ways to make more of the cash they earn stay in their household and even use their cash flow to create more income.

The average family has a straight cash flow where every dollar that comes into their bank account flows right back out again.  Not only do they not build wealth, meaning that they are looking at a retirement in poverty, but they also face the risk of racking up debt when there is an event that causes their expenses to spike in a given month, causing them to take on debt.  This then adds to their expenses and they start to sink into the abyss.

A. Income:  Obviously this is your income for the month or the year.  This includes income from work and other activities, along with investment income.  The goal is to grow investment income to the point where work income is no longer needed since that will be point where you become financially independent.

B. Cash on Hand:  This box includes bank accounts and other liquid assets.  This is where money rests until being spent or invested.

C. Obligated Expenses:  These are expenses that you must pay or you pay a fee or get thrown in jail.

D. Necessary Expenses:  These are expenses that you need to pay to survive, like food, but you have some flexibility on the amount and how you cover a given category.

E.  Optional Expenses:  These are things you really don’t need, but which make life better, like movie tickets.

F. Required Investments;  These are investments you should be making for big expenses that you’ll face eventually, like retirement.

G.  Saving and Investing:  This is the money you put away to generate an income and become financially independent.  It is also the saving you do for big expenses like your next car to keep you out of debt.

So there you have it – the basic cash flow diagram.  Note that money flows in through the top into your bank accounts, and then whatever doesn’t stay in your bank account flows out to expenses and investments.  Because most people don’t see their regular bank accounts grow each month, they have formed an equilibrium where money flowing in equals money flowing out.  People who spend more than they make will have debt instead of savings, which will act like a big suck on their ability to create wealth.

Your free cash flow calculation, which is shown in the upper right, is the money left over after you pay required expenses and investments.  This is the money you have available to become financially independent.  The bigger your free cash flow, the more quickly you can build wealth.

In the posts that follow in this series we’ll talk about how to use a cash flow diagram to understand your finances and put yourself onto the path to become wealthy.

Disclaimer: This article is not meant to give financial planning or tax advice. It gives general information on investment strategy.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.