In my previous newsletter, I encouraged readers to reflect on the significance of money in their lives and how they can transform their relationship with money. This week, we will delve into the topic of cash flows, which is a crucial building block for financial success, even though it may not be the most captivating subject. Understanding cash flows is essential for evaluating equities and businesses, enabling us to project future success and scalability.
Simply put, cash flow entails tracking the inflows and outflows of cash. It involves understanding where our money is coming from (inflows), where it is going (outflows), and how these components can be optimized. While tracking cash flows can be tedious, it is vital for achieving financial temperance and control. We must clean our financial house and grasp our cash flows before embarking on financial success.
In everyday terms, cash flow is about knowing how much money we earn and where it is allocated. However, I challenge readers to adopt a business mindset and think in financial terms. We not only aim to determine if we are cash flow positive (earning more than we spend) but also to analyze our cash inflows and outflows to optimize our financial goals.
For instance, tracking cash flows might reveal that you spend $200 per month on subscription services, which could be reduced to $50, allowing you to save an additional $150 per month for a special dinner with your partner. Or perhaps you aspire to build an investment portfolio for future travel goals, and upon analyzing your cash flows, you discover that you spend $1000 per month on shopping. By cutting this cost to $750, you can allocate $250 toward your investment goals. Although these adjustments may seem elementary, it is surprising how often we neglect them. Do we know exactly how much we spend on dining out, dates, or haircuts each month? Understanding our cash flows is the foundation of our financial success and well-being.
Engaging in this process can be frustrating at times, requiring sacrifice and restraint. However, these are the decisions that business owners and money managers face daily. While our choices may not always be perfect, having comprehensive information allows us to make the best decisions regarding our money.
When I started this newsletter, I intended to provide readers with insights and actionable steps toward their financial goals. Therefore, the next step I propose is to understand our cash flows to reach those goals. For one month, I urge readers to track every expense, leaving no exceptions meticulously. If you have already been tracking your cash flows, that’s fantastic. For those who haven’t, this is an opportunity to learn and take action toward improving your financial well-being. Create categories for your spending, such as Recreational Activities, Uber, Eating Out, Haircuts, and Subscriptions. At the end of the month, review all your statements and allocate each charge to its respective category. Next, total all your income, including employment income, rental income, disability income, business income, and any other cash inflows. Now comes the moment of truth—ask yourself if you are cash flow positive or cash flow negative. Even being cash flow negative isn’t necessarily a bad thing; it’s crucial to understand your current situation to make informed decisions.
Whether you are cash flow positive or negative, there are ways to optimize your cash flow and better align it with your financial goals. For example, you might realize that you spend $800 per month on pet care, and by reducing this expense, you can contribute more to your retirement account. Alternatively, if your cash flow is growing, you might consider investing in your first rental property to generate additional income streams. All these decisions start with a foundational understanding of our current cash flow situation and how we can optimize it.
When analyzing a business to invest in, one of the first questions I ask myself is whether the company is making money. If they aren’t, I delve deeper to understand why. Is it a temporary situation or a fundamental issue that may be difficult to resolve? This same principle applies to our personal financial success. Do we have a positive cash flow? If not, what are the reasons behind it? Is it a temporary setback or a more significant problem related to debt and deficits that may require more effort to address?
In equity investments and stocks, analysts use cash flows to assess the financial health of a business. Cash flows indicate the funds available for capital expenditures, dividends, and share buybacks. While we may delve into equity analysis in the future, I mention this to emphasize that we can apply a similar approach to our personal finances. What are our cash flows? How can we reinvest in ourselves or pay ourselves as investors? Are we accumulating free cash to make a significant purchase, or are we reinvesting our cash flows? The answers to these questions vary for each individual, as there is no one-size-fits-all solution.
By understanding our cash flows, we can make informed decisions about how to optimize our financial resources. We can identify opportunities to reinvest in ourselves, save for future goals, or make strategic purchases. Evaluating our cash flows is an essential step in becoming effective wealth managers and achieving long-term financial success.
Finally, I want to emphasize the importance of taking this topic seriously. Don’t skip over charges, avoid confronting your cash flow reality, or overlook slippage. Our objective is not to judge ourselves or restrict our financial freedom but to gain a clear insight into our financial behavior and become better wealth managers. These adjustments are part of an ongoing process, and it’s crucial to remember that investing in ourselves is a journey that continually evolves. Once we comprehend our cash flow situation, we will be better equipped to set achievable financial goals that yield tangible results.
I hope this week’s newsletter has provided valuable insights and motivates you to embark on this cash flow journey. Stay tuned for more actionable steps and strategies to reach your financial aspirations.