Cash flow is arguably the most valuable money management tool. It is used in concert with net wealth and balance sheets to develop a successful money management planning strategy.ย Budgeting, systematic savings, debt payments are all part of our cash flow.
Cash flow is a comparison of money in versus money out.ย If net worth is to grow, money in must be higher than money out.ย Though simple in principle, this is seems to be difficult in practice.ย For example, the concept of “burn more calories than you take in” is simple concept as well, though as a society we seem to have just as much trouble with it.
In terms of analysis, one of the primary differences between net worth and cash flow is how they measure.ย From a math perspective, I tend to think of these two in the discrete versus continuous variable framework. Net worth is discrete.ย It measures an indivisible, specific point in time.ย Your calculated net worth is your net worth at that point in time. Conversely, cash flow is continuous.ย It measures your cash flow over a period of time which can be further divided up into smaller sections without losing its intrinsic value.ย You can measure your cash flow monthly, over six months, etc., whatever suits your needs.
Though you may only measure your net worth annually, you should measure your cash flow monthly when just starting out in order to identify trends.ย If you’re more confident in your progress, maybe you’ll measure it quarterly or semi-annually.
Managing cash flow is the lynchpin of a financial planning strategy.ย With a positive cash flow surplus funds can be directed towards goals like retirement, education plans for children, building an estate, investments, etc. With a negative cash flow, these things are not sustainable because sooner or later, the money will run out.
