If you watch Shark Tank, you’ve heard entrepreneurs reassure the investors that their businesses are cash flow positive. They know investors like hearing this because it means the entrepreneur is doing one very important thing right — making more money than they’re spending.
A business cannot survive and thrive otherwise, and neither can yours.
Don’t own a business? Oh, yes you do. We’re not talking about the business of owning a company; we mean the business of running your personal finances. If you spend more money than you make, you’re cash flow negative and, just like a business, you can’t grow wealth that way.
What is cash flow?
The traditional cash flow definition refers to the business side of finance: “The movement of money in and out of a business.” However, the concept is one that can (and should) be applied to your personal finances as well.
How to calculate your cash flow
Some careful bookkeeping and simple math are all you need to figure out your cash flow.
- Add up your monthly income. How much money came in last month? Include regular sources of income, like salary and wages. Also include any unusual or irregular income, like freelancing, renting out your house, or selling your clothes.
- Add up your monthly expenses. How much money went out last month? Include fixed expenses, like rent, utilities, insurance, car payments, and student loan payments. Also include discretionary expenses that can vary from month to month, like what you spend on groceries, travel, gifts, entertainment, car repairs, and doctor copays.
- Subtract total expenses from total income. This is your net cash flow. If it’s positive, you’re spending less than you make. Your finances are in good shape! If it’s negative, you’re spending more than you make. Your budget needs some work.
Keep a record of your numbers every month and you can use them to figure your net cash flow over longer periods of time, be it quarterly, annually, or every six months.
Why knowing your cash flow helps
When it comes to personal finance, the most important rule to live by is this: Spend less than you make. And the only way of knowing whether you’re doing that is to keep track of how much is coming in and how much is going out.
Having a general idea isn’t good enough
For instance, maybe you already know that you’re cash flow positive. You don’t charge anything to credit cards and the only money you spend every month is the money you make. That’s great, but what it doesn’t tell you is exactly how much money you have left over at the end of the month to put toward your financial goals.
On the other hand, maybe you already know that you’re cash flow negative. You charge everything, carry credit card balances and, in turn, spend more than you make pretty much every month. That’s not good, and it doesn’t tell you is exactly how much money you need to cut from your expenses so that you can move into positive territory.
Are you cash flow positive?
If you got a positive number after calculating your cash flow, that’s how much money you have every month to put toward your financial goals. Maybe you want to pay down loan balances. Maybe you want to start an emergency fund. Maybe you want to save for the down payment on a house.
Whatever your financial goals, positive cash flow makes them possible. The key is knowing the exact figure so you know how much you can put where.
But don’t rest on your laurels.
Being cash flow positive is great, but you might be able to do even better. To create a bigger positive difference, earn more money or dig into your discretionary income to cut expenses where you can.
Are you cash flow negative?
If you got a negative number after calculating your cash flow, that’s how much money you must cut from your expenses or add to your income. But don’t settle for just breaking even.
It’s true that spending exactly what you make is preferable to spending more. However, you need positive cash flow to build any personal wealth.
You may not find yourself standing in front of investors asking them to believe in your business. But every time you look in the mirror, you’re standing in front of someone who has the power to make or break your personal finances. Do the budgeting work and start investing in your future wealth.
Want help tracking your cash flow?
There’s an app for that – several of them, in fact. Take your pick from the best budgeting apps out there. Keep it simple with Level Money, Wally, or Dollarbird, or get a little more comprehensive with Mint, LearnVest, and YNAB.
Now that you know how to calculate your cash flow, do it! Use whatever tools and systems work best for you. Once you’ve found your magic number, start building your wealth one penny at a time.
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