Cash Flow is King

by | Jan 16, 2024 | Blog

In my last post, we briefly touched on the importance of cash flow and balance sheet in the financial planning process.  Let’s dive in even further!

Why is Cash Flow the “King”?

When it comes to financial planning, almost any recommendation or tweak that someone can make to improve their situation comes from cash flow.  During our process, we create a statement of cash flow and a balance sheet for each client.  This allows us to see the full financial landscape and understand where a client currently sits before making any sort of recommendations.

We discuss cash flow quite a bit.  Just a few weeks ago, Tom discussed the importance of cash flow on Episode 364 of the Mullooly Asset Show!  If you missed that episode, you can watch it quickly HERE.

Let’s back up a little bit, though.

What exactly goes on a statement of cash flow?

A cash flow statement measures inflows and outflows over a specified period.  It could be monthly, quarterly, annually, etc.  “Inflows” and “outflows” are pretty self-explanatory.

Inflows are sources of income coming IN.  That could be from a regular salary at work, dividend or interest income from investments, capital gains, rental income, Social Security benefits, and more.

Outflows are sources of money going OUT.  There are two types of outflows that an individual can have: fixed or variable.  Some examples of fixed outflows would be mortgage or rent payments, car payments, insurance premiums, property taxes, utility bills.  These fixed expenses remain mostly the same monthly.  Variable outflows could also be called “discretionary expenses”.  Some examples are food, clothes, entertainment, home maintenance, vacations, charitable donations, etc.

And what goes on a balance sheet?

A balance sheet is a way to measure somebody’s net worth.  The equation for finding net worth is somebody’s assets minus their liabilities.

Assets can be anything from cash, checking or savings accounts, or CDs to annuities, real estate, pensions, IRAs, collectibles, stocks and/or bonds.  An asset can also be your home or personal property, cars, or vacation homes.  Assets are generally shown at fair market value.  That reflects what buyers are willing to accept for the asset.

Liabilities are any debts that a person might have.  Those debts could be short- or long-term debts.  Anything from a credit card balance or personal loan to your car loans and a mortgage fall under the category of liability.

How does the statement of cash flow and balance sheet factor into the financial plan?

When it comes to fixing financial problems, a LOT of them can be solved by fixing cash flow problems.  Proper cash flow management is crucial for financial success.  The common word “budgeting” sometimes gets a bad reputation.  If you reverse the normal thinking of “my budget tells me everything I CAN’T buy” to “my budget is identifying all of the things I CAN buy”, you might be more inclined to follow that budget!

If you’re creating a budget for you or your family, here are a few guidelines for establishing a basic budget:

  • Make the budget flexible enough. Not TOO flexible (that serves no purpose) but not TOO strict.
  • Establish the period this budget covers. Are you budgeting for the entire year? Or just a month?
  • Keep it simple (PS – this rule applies to a TON of areas in finance)
  • Keep track of everything! It becomes so easy to let expenses slip through the cracks each month/year.

A lot of the questions we get asked about financial planning or investing stem back to cash flow questions.  This is especially true during the retirement planning process.  Projecting retirement income is extremely important for those getting ready to retire.

During the Data Gathering process, we try and compile as accurate a list of monthly/annual expenses as possible so that we can carry that forward into retirement.  For most (not all) people, retirement doesn’t come with a massive lifestyle change attached to it.  We run an exercise assuming the client wants to continue living their life the way they currently are, but without their employment income.

This stresses the importance of monthly cash flow.  The outflows need to be as accurate as possible because with inaccurate data, the retirement income projections won’t be very useful.  It also allows us to identify sources of inflows in retirement.  Income usually consists of pensions (if any), Social Security, banked savings in any capacity, and the investment portfolio.

Cash flow management is incredibly important to more than just retirees, though.  The same concept can be applied to young couples saving for a home or saving for a child’s education.  Figuring out what the monthly numbers are allows us to identify how much can be saved monthly and where to save it.

Even decisions as small as figuring out how much to send to your workplace retirement plan each paycheck comes down to cash flow.  Depending on your goals (short and long term), it may make sense to send more or less into your 401k and have more or less in your monthly paycheck.  We often times see people taking loans from their retirement plans when they would’ve been better served keeping that monthly in their paycheck and having it available in monthly cash flow.

If you’re not a young couple or approaching retirement, cash flow is STILL incredibly important.  Addressing any financial goals you might have starts with addressing your cash flow and knowing where every single dollar is going.  A lot of times, even just the exercise of Data Gathering for folks is eye-opening.  It becomes so easy to get unorganized and lose track of where your money is going.  Taking the time to sit down and track every single dollar can help folks realize where the excess is and where they can afford to spend a little more.

Getting a firm grip on managing your cash flow falls into the “simple but not easy” category for a lot of people.  We can understand and appreciate the difficulty involved in day-to-day life and juggling a million things at once.  That’s why we’re here to help!  If you have questions, or need help managing your cash flow, click the “Schedule a Consultation” button at the top of this page.  We would be happy to have a conversation with you.

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