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Easy cash flow rules to live by…
Wealth accumulation and management of our own finances are hopefully, issues we think about and are aware of the minute we become solely dependent on ourselves. Usually, this becomes a reality for some after high school graduation, others during, or after college. Regardless of when it starts, it is typically (or should be) a consciousness in our minds everyday we live whether, planning for the present day, or planning for the future. With increasing awareness of fiscal responsibility, individual cash flow should always be one of the very important aspects to be taken into consideration.
I believe that cash flow is a very good method for an individual to rate his/her state of financial security. Other terminology that is important to take note and to have an understanding of is assets, liabilities, and working capital. I’ll get the definitions out of the way. Entry of these terms into your favorite search engine such as Google, Yahoo, or Microsoft Live would yield a slew of definitions. Although these definitions are always skewed towards an organization or business entity, they are still very applicable to the individual, being that we as humans are also entities in our own right.
Cash flow can be defined as the rate at which money comes into your purse (or bank account) and how it leaves your hand. Asset is what you own that is of value such as a house, a boat, money (in bank accounts), investment securities (such as stocks and bonds) and other properties that can be converted into cash. These assets can either increase in value, or gradually decrease in value. So it behooves an individual to favor assets that have an affinity for appreciation not depreciation. Liabilities are what you owe to other entities that you have to pay back (or are responsible for), usually synonymous with debt and bills.
Working capital is simply a person’s current assets minus current liabilities. In a sense, your working capital is your real wealth value. If you have thousand dollars in the bank (asset) but owe nine hundred dollars in credit card debts (liability), then what you are really worth one hundred dollars not one thousand dollars. If you continue to operate as though you are worth more, then you are opening yourself to financial issues. The way a person mixes his/her involvement in assets, liabilities, cash flow, and working capital can in effect shape their financial destiny.
Time and time again, if you turn on your television and pay attention to any of the news channels long enough, you will invariably hear stories about supposedly wealthy people going into serious problems with finances. Such people have a very high standard of living as a result of the assets they have acquired over the years coupled with the amount of liabilities that they are responsible for. They continue to generate cash from whatever activities they are involved in, and the liabilities and assets continue to increase, usually in a haphazard manner. Should the source of income suddenly terminate, they are left with their assets, liabilities, and a standard of living that would need serious readjustment.
A situation like this should force a new approach for the management of existing liabilities/debt. This approach usually falls into two categories, the first being the maintenance of liabilities (e.g. monthly payment of utilities) and the second, reduction liabilities (e.g. reducing accumulated debt, loans, etc) – both attainable by looking more other way to generate more cash, or liquidate assets. As easy as it may seem, liquidation of assets that you have grown accustomed to, especially if they provide luxury, are hard to part with as it forces you to further change your behavior. This scenario described above is an extreme case, and should be curtailed with a dose of reality before it becomes an issue. You are better off maintaining control and not walking down that path. Mind you, this example happens as much to the rich guy as it does to the less opportune. Why? Because it is not so much the level of wealth a person flows in, but the mindset that a person has.
Cash Flow Rules to Follow:
This is where cash flow comes in. Management of Cash flow serves as your barometer or tangible metric for realizing if your wealth level is maintained, increasing, or depleting
1. Level of Cash Flow Maintainable
You should not acquire any more assets because you don’t have the money with which to obtain it without going into negative cash flow. Negative cash flow ultimately leads to increased borrowing to cover costs, which leads to debt. Also, you cannot wisely acquire more liabilities without seriously putting your self in a risky position. In situations when faced with a need to acquire more financial liabilities, realize that the state of your finances is threatened regardless of whether it is considered “good” debt, or “bad” debt. A debt is never good, if already in negative cash flow, because your cash flow is what you would use to fulfill installment payment obligations.
2. Level of Cash Flow in Depletion
This can be due to unprecedented increase in liabilities or reduced income. If faced with this position, start streamlining on the liabilities and making hard decisions on what needs to be reduced before things get out of hand. Standard of living has to change in this scenario. If an increase in liability, you would have to examine yourself to figure out what things, people or daily events cause you to over-extend yourself. Another option is to looking into generating more income; however that doesn’t always solve the underlying problem, but makes it easier to deal with.
3. Level of Cash Flow on an Increase
Do not go berserk on spending. Reward yourself occasionally and with wisdom. Immediately begin to reduce debt as this works towards improving the quality of your working capital. With debts on the decline, you can continue to acquire more assets and hopefully lean more towards those that appreciate than depreciate. You are fortunate and should not ruin your increasingly stellar financial position. Be prudent when it comes to accumulating liabilities.
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