Cash flow has two components: what goes-in and what goes-out. You might know them as income and expenses.
Income is any money that flows your way. This might be money you earn through a job or a hobby. It might be from your investments in the form of income or dividends.
An expense is the money that leaves you. It might leave you before you even see it such as through tax withholding. It could be money that turns into tickets to Disney World or a movie. Mostly it’s the mundane: your rent, electricity, groceries, and gas.
Related to cash flow is net worth. Net worth is the summation of everything you have (assets) and everything you owe (liabilities). I won’t go into this in great detail right now, except to mention the concept of delaying cash flow.
Let’s say that you got a Christmas bonus (a rare thing these days). Instead of spending it, you decided to save it for a future kitchen remodeling. In a way, you are delaying the flow of cash through your system. The money came in, but it hasn’t yet gone out. This type of saving is called an asset.
On the other side of the equation, you might have an expense with no income or savings to support it. Let’s say that you buy a car that costs $25,000. You don’t have savings for the car so you go out and obtain a loan. In this case, you’ve spent money that you didn’t have. The loan becomes a liability; the car is an asset. You have again delayed the cash flow. But it is only delayed; eventually you’ll have to flow cash out to pay off the loan.
Most people haven’t a clue what their cash flow is. If this is you, take some time to determine yours. First, make a list of all the income you anticipate coming in the next year. We want to look at gross income; that’s the income before any expenses come out. So look at your paycheck, social security check, or other earnings, prior to the deduction of things like taxes, health insurance, and other expenses.
Now, list all of your expenses. Taxes will be a big category. The monthly expenses will be easy to determine, the annual ones will be a bit more difficult, and the less than annual will be hard to get a good grasp on. Nevertheless, do your best. Don’t forget vacations, car repairs, and the like. Estimates are fine for now; you’ll have plenty of time to adjust as time goes on. Though not a true expense, go ahead and make a category for any money you have going into savings or investing.
Here’s the test. Compare your income to your expenses. They should be pretty close to equal. After all, all the money that you made is going somewhere. If it is not being spent then it’s being saved or invested. If you’re having a really hard time doing the current year, then try looking back at last year to see where all your money went.
Keep working on your income and expense list until they come within about five percent of each other. When you’ve completed this exercise, you will understand your own personal cash flow.
Gary Silverman holds the Certified Financial Planner (CFP®) license and is a member of the Financial Planning Association (FPA®). Gary is the founder of Personal Money Planning, a retirement planning and investment advisory firm, and is a Qualified Kingdom Advisor.
Views expressed are the personal views of the author, and do not represent the views of the National Foundation for Credit Counseling, its employees, its members, or its clients.