Do you know where your money goes every month? If not, understanding your personal cash flow will help you better manage — and measure — your funds.
What is cash flow?
Cash flow refers to your income minus expenses over a set period of time. This term is helpful for both individuals and businesses as it can clearly indicate what direction finances are heading.
Most people will measure their personal cash flow on a monthly basis. They’ll look at how much they’ve made and how much they’ve spent. While this is a great way to manage your finances, some people may forget to budget yearly expenses, such as insurance or holiday spending. When those costs eventually come up, they may not have the funds available, making their finances cash flow negative. Getting your personal cash flow under control is a money management skill you’ll want to master.
Businesses determine cash flow by comparing how much comes in from sales with how much it costs to keep things operating. Depending on the company, cash flow may change drastically depending on the month. In an ideal world, every month is cash flow positive for a business, but there may be months with less income. If you start a small business, cash flow is an important concept to understand.
How to determine your cash flow
Anyone can determine their cash flow by creating a budget. All you need to do is write down your monthly income, including sources of passive income, and then subtract all your expenses. Instead of focusing on a single month, you may want to track your expenses for three months. You’ll have a much more accurate picture of where your money is going and how it contributes to your net worth.
Why should you care about your personal cash flow?
While being cash flow positive (where your expenses don’t exceed your income) is great, you’re basically living paycheque to paycheque if you don’t have any savings built into your budget. Having an emergency fund is vital, as it’ll give you a cash injection if something major comes up, such as an unexpected repair or medical expense.
Cash flow is also vital when thinking about the future. If you’re able to save money every month, you can make smarter money decisions in the future. For example, you could purchase things without having to go into debt, or try out some investing approaches for beginners.
If you think big picture, being cash flow positive is something you’ll want to be if you plan on buying a home in the near future or achieving financial independence.
On the flip side, let’s say you’re cash flow negative. You may fall into a debt spiral in these situations, which could ruin your finances or potentially tank your credit score.
Addressing cash flow problems before they get out of hand is essential.
How to improve your personal cash flow
Creating a budget and tracking your expenses is the first thing to do if you’re looking to improve your cash flow, but you should also consider a few other tips.
Use the 50-30-20 rule
The 50-30-20 rule is a budgeting trick. The idea is simple. You put 50% of your income towards necessities, such as rent/mortgage, groceries, transportation and internet/cell phone. Another 30% goes to your wants, which may include entertainment, clothes, eating out, etc. Finally, the remaining 20% is for savings.
If you’re able to stick to this plan, you’ll likely have no problem reaching your financial goals. That said, if you live in an area with a high cost of living, you may have to dedicate more of your budget to housing.
Slash your expenses
Since you’ve created a budget and tracked your expenses, you’ll know exactly where your money goes. With that knowledge in mind, you could start trimming back on your expenses.
Your monthly bills are a good place to start. For example, maybe you can cut or reduce your streaming services, get a cheaper internet plan, or follow tips to save money on groceries.
Alternatively, using price matching to ensure you’ve scored the best deal could go a long way.
Automate your savings
Many people will wait until the end of the month and save any leftover money. However, quite often, there’s nothing left to save. Why not flip things around and pay yourself first? Set up automatic withdrawals that go right into a high-interest savings account. If you time this for when you get paid, you won’t even notice the money missing from your paycheque.
Improving your cash flow doesn’t happen overnight. Think about your long-term goals, like saving for retirement, and develop a plan that will get you there. It might seem like you’re climbing a mountain, but every step you take will bring you closer to the peak.
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