Personal Cash Flow – Liquidity for the Thirsty!

Do you find that many weeks, more money seems to be going out than coming in? Do you earn reasonable money and can’t work out why it’s so hard to make ends meet?  The answer might be surprising; cash flow. Cash flow is a business accounting concept, but don’t let that discourage you. It could be vitally important for your personal finances.  Cash flow refers to the movement of cash into or out of your possession, or the amount of “cash” you have on hand to pay expenses.   It you don’t get it right, you’re in trouble.

Many profitable businesses fail because of a shortage of cash.  Likewise, many people on good money get into trouble because they have a shortage of cash. Cash refers to money in the bank or in your wallet. Many people calculate their income and expenses on a yearly basis, but this approach can be misleading. Your income might exceed expenses over the whole year, but bills and expenses don’t come around once every year, they show up monthly, or even weekly. If you don’t have enough cash available to pay the bill when it arrives, you are insolvent.

Example:

Jim just started a new job.  Jim has no savings.  Both his registration and insurance are due this week. What is his cash flow?

Jim earns $1000.00/week

Car insurance is $750.00/year

Car registration is $750.00/year

In the above example, Jim is clearly able to afford his expenses. But since both bills came at the same time he is left with negative cash flow. Jim would have no choice but to default on the bill. Most peoples’ finances aren’t that simple.  They have multiple expenses due on different dates with different frequencies. They’re juggling weekly rent payments with, quarterly electricity bills, annual insurance bills and monthly pay.  It’s easy to see how this can be difficult to budget.  Throughout the year there will be cash surpluses and cash deficits.  It’s easy to spend cash surpluses and be unable to pay your bills.

Everyone has heard the expression “cash is king”. It doesn’t matter how much “profit” a business makes.  If it doesn’t have cash available to pay bills when they’re due, it will go bankrupt.  Likewise, with personal finances it isn’t just about how much you earn.  If you don’t have cash to pay your bills, you will end up in trouble.

Businesses don’t do “budgets”.  They do “Cash Flow Budgets” and so should you.  The difference between a normal budget and a Cash Flow Budget is that it breaks up the year into manageable portions (weeks, months, quarters) instead of whole years.  Generally a cash flow budget will use months as most bills have 28 day terms, however if you have weekly bills it might be better to break it down to weekly increments.   Break up the year into monthly lots.  Enter the income and expenses as they occur every month.  If the registration is due in October it goes in October.   Next, total each month up.  You should find that some months will have a negative result (negative cash flow) and other will have a positive result (positive cash flow).  This shows you that you need to keep that cash surplus from previous months to pay for expenses that will occur in the future.