Cash is much like water.
Let it sit too long and it stagnates, but if it flows too fast, that ‘pond’ dries up, leaving you high and dry.
Whether you agree with the cliche, ‘cash flow is king’ or not, all of us, employees, business owners and retirees, it’s vitally important to keep your cash flow in check.
To help you keep your money moving in the right direction, we’ll explore the concept of ‘cash flow’ and give you some tips on how to adjust both ends of the faucet.
What is cash flow?
Cash flow is simply how much money is coming in and how much is going out.
Finding the right cash flow for your lifestyle is an important financial skill for everyone, however, it doesn’t come naturally to many. It takes study, patience and practice to keep the ideal amount of cash flowing to both prevent dry spells and manage influxes.
Let’s take a look at how you can ensure the optimal cash flow for you, while avoiding the twin pitfalls of over-spending and over-saving.
The twin pitfalls: stagnant money VS a dry bank account
Good cash flow is all about balancing on middle ground – maintaining enough cash in your account to pay for expenses without leaving money sitting fallow.
Overspending, or a cash flow which empties your accounts, can cause major problems. It can mean being unable to afford a vacation, being unable to repair your car, or for some, it can even mean no groceries that week.
However, hoarding cash is not the answer either.
By hoarding cash, we create stagnant pools of money that do little but recede in value, courtesy of inflation. That means the pool of money you’re keeping to ensure there’s enough money for everything is also losing purchasing power every day it sits.
The key to good cash flow is two-fold:
Ensure you have enough cash to cover living expenses, emergency expenditures and impulse purchases.
Ensure any excess cash is being put to work for you i.e. investments or tax-free savings accounts.
Now let’s take a look at some tips that will help you dial-in that ideal cash flow.
Tip #1: Projecting cash inflow and outflow (aka budgeting)
The first step to managing your cash flow is to understand what your revenue and expense streams will look like going forward.
Now, no one has a crystal ball to predict the future of their finances. However, by examining past year-round expenses, it’s quite possible to predict with sufficient accuracy how much money you will need at any given point, and how much you’ll have coming in.
To do this, begin by adding up all of your usual expenses from the last year or two. This should include everything from discretionary spending to monthly bills and payments. Make sure to note where spending goes up, like around Christmas or other holidays, and where it recedes.
This will help you craft a spending plan, or in other words, a budget for the future, which should keep your outflow below your inflow (or income).
Tip #2: Balance money-making assets with liquid assets
Now that you have a clear idea of how much money is flowing in and how much is flowing out, you can decide to adjust the flow. Though it may be tempting to dam up the flow to create a lake, it’s best not to get too carried away with pooling your cash.
Instead, put any excess cash to work for you by investing. This will help you fight inflation by growing your money faster than inflation digs into its purchasing power. However, many investments, whether physical infrastructure like property or equipment or financial investments, can take a hit in value if you need to pull your money out (or sell) unexpectedly. That means if an emergency comes up where you need to dip into your savings, you’ll be penalized.
You can help avoid these penalties by making investments with different levels of liquidity, which is a measure of how easily your assets can be converted to cash. Highly liquid assets (such as a savings account) can be quickly cashed in, while low-liquidity investments (like a house) will take more time to turn into cash.
Balancing low-liquidity investments with high-liquidity assets allows you to maximize the earning potential of your cash. Meanwhile, you still have access to emergency cash in the short term.
Tip #3: Work with your debt
Debt never feels great, but leveraging it wisely can help you balance your cash flow when you need to make large purchases. By staying out of debt, you have to either:
Save large pools of cash, leaving your cash vulnerable to inflation
Sell investments early and risk taking a hit on their value
However, debt allows you to make those big purchases without making a mess of your investments or losing value through inflation – especially if you can find loans with interest rates below 3% (the average rate of inflation). This also enables you to maintain your usual cash reserves that will protect you from emergency expenditures.
Maintaining ideal cash flow for your lifestyle
By maintaining proper cash flow in your business, retirement, or day-to-day life, you can take control of your finances. Not only is this personally empowering, but it means you’re expertly balancing that line between having enough for unforeseen expenses, and making your money work for you.If you need help organizing your cash flow, a professional financial adviser can help. Contact the Bayview Financial team today.