Jumping off with Financial Literacy, Part Two: Cash Flow
Do you have the financial understanding to start yourself out on the right foot?
Financial basics: Cash Flow
Does your annual income cover your annual expenses? Do you know how much you spend in a year? Tackling your annual cash flow can be an intimidating prospect. The idea of examining past expenditures may make many people want to bury their head in the sand. While daunting, I encourage you to examine your annual cash flow as a basic step towards a firm financial foundation.
Cash Flow Calculation
Calculating your cash flow is a fairly simply calculation: Income – Expenses = Cash Flow. It’s important to understand that a cash flow calculation is over a period of time. You can do monthly or annual cash flow calculations. I would encourage you to do both. Your annual cash flow calculation will give you an idea of how much extra cash you’re generating in a year (or how much you’re falling short). Monthly, your calculation will tell you if you’re covering your bills or if you’re having to resort to using credit cards to cover a shortfall (even if you’re ending up positive at the end of the year).
What is Income?
Income is any money coming in. It may include:
- Salary from a job or business
- Commissions or tips
- Income from real estate rentals
- Investment income
- Spousal support
What amount should you include in income? If you’re looking at your pay stub, you’ll see that you have a gross amount, which was what your employer actually paid you. You will then have a net amount, which is your pay minus expenses such a taxes, health care premiums, parking, etc. I recommend using the gross amount of you pay and including all those deductions in the expense side of the calculation. Using the gross pay and including all deductions from your paycheck as expenses will give you a fuller picture of your cash flow situation by revealing harder to notice deductible expenses.
What if your income comes from a business or rental property? You may want to set up a separate cash flow calculation for these entities and use the net income from those sources in your personal cash flow calculation.
What are expenses?
Expenses are any money going out. They may include:
- Mortgage or rent
- Taxes
- Other paycheck deductions
- Insurance (including homeowners, renters, vehicle, life, etc)
- Utilities
- Loan payments (monthly payments, not the full amount of the loan)
- Credit card payments (monthly payments, not the full balance)
- Childcare
- Food, gas, entertainment, etc
What amounts should you include in expenses? I recommend using the exact amount you paid for each time period. It may be more difficult to go through each month’s statement to get to the actual dollar amount but looking at these (rather than averages) will help you identify spending trends and where you may be able to cut back.
What Does My Cash Flow Tell me?
Now that you’ve calculated your cash flow, what does it mean? First, let’s look to see if it’s a negative or positive number. If it’s positive, great! You’re bringing in more income than you’re spending. If it’s negative, you’re spending more money than you make, and it’s time to figure out why.
What Can I do if I have a Positive Cash Flow?
So you’ve determined that you’re making more money than you’re spending. Congrats! You’re on the right track. It’s time to figure out what to do with your extra funds. Examine your debt and determine if your extra cash may be put to better use paying down high-interest debt such as credit card debt. How’s your emergency fund? If you have a positive cash flow, it’s time to secure that emergency fund. See my blog post here (coming soon!) on details on how to prioritize your savings.
What Can I do if I Have a Negative Cash Flow?
If you’re finding you’re spending more than you make, it’s time to take a hard look at both sides of the calculation and see what changes can be made. To make a positive impact, you will need to increase your income, reduce your spending, or both.
For increased income, address your main source first. Can you put in for a promotion or raise? It usually doesn’t hurt to ask. If you don’t find opportunity at your current position, it may be time to find a new employer. Use your newfound knowledge of your financial situation as motivation to make a big change.
For decreased spending, take a look at your variable expenses such as shopping, food, and entertainment. Is there a lot to cut here? This may be enough, to get you back to a positive cash flow, but you can only cut down your variable expenses so much. After variable, take a look at your fixed expenses such as your rent, mortgage, or insurance payments. For more info on fixed and variable expenses see my post here (coming soon!).
Need more help with your cash flow? Contact us at Old Growth Financial so we can help you get back in the black for a better financial future!