What is cash flow in relation to your personal finances? This is the first of two articles, the next being on how to fix cash flow issues.
Take a listen to the Cape Talk Radio interview about this post on what cash flow is.
What is cash flow?
Cash flow is the amount of money coming in to your account and the amount of money going out. Think of it as a water tank: water comes in at the top and drains out the bottom. So to keep your tank nice and full, you want more coming in than going out.
Cash flow is generally a term used in business and it may sound like something that doesn’t matter to individuals – especially if you’re working in a full-time job and earning a stable salary. Well, it does matter and it matters a lot!
I want to explore a very common money mindset, and one which I used to have myself. And then I’m going to delve into a new way of doing things. The actual implementation of it may take some time and I will add some blogs about that too.
Misconception: Cash flow doesn’t matter to me
We are “trained” by financial institutions not to worry about our personal cash flow. In fact the very institutions that promise to be looking after our best interests are the ones that keep insisting on giving us credit cards, over draft, loans, and “easy access to funds”. They make it seem normal and acceptable to buy things now when you really don’t have the money. We somehow believe that because we will have the money at some point (when we get our salary) that it’s okay to spend now on credit.
What this really means is that we are spending money before we even get it. The problem is that when we don’t get the money we expect then we are in huge trouble. Of course, the financial institutions have a solution for that; they simply give us more credit and we have to hope that we will at some point actually get money.
Does any of this sound familiar? It is the start of the endless pit of debt. Now you may be like me and feel that things are in control. Until recently I used to save away my salary when I received it in my bank and then live off my credit card for the month and pay it off when I received my next salary. My debt never really grew as I kept paying the due amount on my card each month, but in reality I was in debt! And let’s just get this straight; debt is bad! Have a look at Tumi’s debt story.
Think of the water tank analogy, when the tank is empty, you can’t use any more water. We’re accustomed to borrowing water and hoping that it may rain some day. We should really be storing up the rain and using it sparingly. Rather have a full tank than an empty one + debt.
So what does all of this have to do with cash flow?
It’s really simple… you cannot spend money that you don’t have. It doesn’t matter if someone owes you a million rand (dollars or whatever currency); if you don’t physically have the money then you shouldn’t be spending it.
Why not, you may ask.
It’s simple, there is no guarantee that you will get it when you expect it (or ever). Life is unpredictable, contracts and promises are broken and employment is never guaranteed.
It’s a known fact that huge multi-million rand companies have gone under because of cash flow problems. You cannot keep operating without having actual income, and more income than just to pay off debt.
The solution is really simple in theory, but hard in practice. It could take you a few months to implement in ones personal finances. Here it is in one sentence.
Don’t spend money you don’t physically have.
That means, if you only have R2,000 in your bank account then you can only spend R2,000 until you receive more money. Even if you have a credit card with R25,000 available. The credit is not your money so you should not spend it! (You can still use your credit card, but only to the value of money you have sitting in your bank account)
Most people are in a cycle of using their monthly salary to pay for previous months purchases, debt, credit cards, store cards, etc and then there really is nothing left. The only option seems to be to continue the cycle.
The solution is to be in a position where the salary you receive is allocated to expenses going forward, not backward. Perhaps this image makes it clearer.
Option 1 (top section) depicts when you feel you never have money and your money simply disappears as soon as you get it.
Option 2 (bottom) is when you have a positive bank balance and you can plan what to spend your money on without needing debt or credit cards.
So cash flow really is the flow of money coming into your account and going out. And if it’s leaving before it’s arrived then there is something wrong and you’re headed for a potential disaster. Any small unplanned event could trigger a financial disaster.
Have a look at the next piece on how to fix cash flow issues and how to start changing the cycle to a “forward spending” one.
Reblogged this on Ongoing Saga.