What is cash flow? In literature terms, it seems like flow of some amount of cash. Didn’t it sound weird? In finance, it means the amount of cash or cash equivalent being transferred in and out of a business. But what does it means in a personal life? Have you heard the term cash flow? When did this term get introduced to you? I guess most of the people come across this term when they start their professional carriers and get a job profile to deal with the financial aspects of business of their companies. People from commerce background may have some chances that they might get introduced to this term during their academic education period. Unfortunately, some of the people never get introduced to this term for entire their life. I am asking all these questions because I believe cash flow is the basic key of financial understanding. Understanding the importance of the concept of cash flow, I have termed, cash flow is the king of financial intelligence. In this article I am not going to discuss about cash flow of a business but about cash flow of a personal life.
Now, the question is, when this term should ideally be introduced to the people? According to me, this term should get introduced right at the time when you get your first pocket money from your parents. Surprised? Now, you might be wondering that I have lost my mind. Why should it introduce at such an early age? Just go through the article you will be able to understand that why I am telling this. I got introduced to this term when I got my first job. I used to calculate and maintain the record of cash flow and profitability margin of my project. Initially, I thought this just a task and I have to keep the record of the cash flow. That’s all. I didn’t get realised the importance of this term until I started getting pressurized by our superior to collect the payment soon from the client, else as the cash flow will be poor, we would not be able to make any payments to our stakeholders to continue the work of our project. This means poor cash flow may leads to stop my project. I was shocked! Even the high profit margin doesn’t matter so much as the cash flow do. Low profit margin with good cash flow can keep the project going, but high profit margin with poor cash flow can stop the project. So managing the cash flow is the uttermost importance in project business. Actually it is one of the most important factors to run any business. These talks might be sounding little boring to those who are not interesting in business. But, it is equally applicable in our daily life.
Now you might be wondering that what we have to do with cash flow in our personal life? Trust me; cash flow is a core part of your personal finance. In our personal life, cash flow means, where your money go what you earn every month. It is the cash flow which determines whether your personal financial condition is healthy or not. If you cash flow is rich, your personal financial situation is good and you are becoming wealthier. If your cash flow is poor, your financial situation is poor and you are not becoming wealthier, irrespective of your income. Now, you might have started understanding the importance of cash flow. Do you face cash crunch at the month end? If yes, it is your poor cash flow which is responsible for this. I guess most of the salaried class people faces this condition. Now you might be thinking, what are the factors which determine whether your cash flow is poor or rich? To understand this, you first have to understand the meaning of an asset and a liability.
Do you remember the meaning of an asset and a liability, which I have introduced in my pervious article? Anything which adds to your income is called an asset and anything which adds to your expense is called a liability. But this is not a complete meaning of an asset and a liability. It is more than that. The real meaning of an asset is something which generates a passive income for you. Here passive income means, you do not have to put much effort to earn those income, it is generated automatically without your much involvement. In simple terms anything which puts money in your pocket without your much involvement is an asset. Reverse of that, anything which pulls money out of your pocket without having much control over it, is a liability. Thus, a liability will generate passive expense for you. In other word, you have to spend anyways to carry a liability. For example, if you live in a house on rent, you have to pay for it anyway. You cannot deny it. It is pulling the money out of your pocket. Thus, it is a liability for you. If you put your house on rent, you will get the rent each month anyway without your effort. Thus, it generates a passive income for you. Since it is putting money in your pocket, it is an asset for you. Also it is important to notice here that same investment can be an asset for one while liability for other. For example, if you buy a car for your personal use, it is going to pull out the money from your pocket as you have to fill fuel each time you ride. Thus, it is liability for you, while if you buy and put your car on rent, it will put money in your pocket. Thus, it is an asset for you.
Now let’s understand cash flow of a common middle class salaried people:
Above shows a common cash flow pattern of an average middle class salaried person. For most of the salaried class people, a major source of cash is their salary. They use their salary for paying taxes, foods, house rent, travel expenses, monthly bills, etc. A major part of the income of a salaried class goes into paying taxes either directly or indirectly. All these are liabilities which pull money out of their pockets. After meeting all these expenses, they save a little cash if remain unused in their saving bank accounts. But this small cash in their saving bank account generates very low cash or poor passive income for them in returns. Here cash flow is poor and they are building a very small or no asset.
Now let’s understand cash flow of a rich corporation or business owner:
Above shows a common cash flow pattern of a person who owns a rich corporation or business. They spent their major part of income in buying shares, stocks, bonds, etc. Also they re-invest a good share of their income in business for their business expansion. Government also provide them tax benefits on expenses for expansion of their business. They are taxed over the income they generate after meeting all their business expense. While salaried class are taxed on their salary, which are not their real income. Income is what a person saves after meeting all their expenses. This way business or corporation owners save a lot on taxes. They are taxed on income after expense, while salaried class are taxed on income before expenses. Also, their investments in shares, stocks, bonds etc. and re-investment in business generates a huge passive income or cash in returns in comparison to saving in bank accounts. Thus, there expense is generating a huge chunk of cash in returns. Here their cash flow is rich and they are building a large asset. It is the income from their assets which take care of their monthly income.
From above two cases, it is clear that it is your expense habit which determines, whether your cash flow is rich or poor. Also, it is the cash flow, which determines whether you are building a large or a small asset. Thus, richer your cash flow, higher will be your passive income while poorer your cash flow, lower will be your passive income. So, now we can say that financial intelligence is nothing but to manage your cash flow. Better you manage your cash flow, more intelligent you are financially. That’s why I termed cash flow is the king of financial intelligence. Since cash flow depends on your habit of expense, I believe that cash flow should be introduced right at the beginning, when we get our first pocket money. Sooner we grasp the concept of cash flow, sooner we able to manage our finance intelligently.
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Hey! I will be back soon with my next very important article: – What is financial freedom? How to achieve financial freedom?