Manage Cash Flow
Step 2 of the Jurnex Process
How to balance between saving, spending, and investing
|Written by Tom Yeung, CFA | CDFA
Investment Advisor & Fund Manager, Jurnex Financial Advisors
There’s a saying on Wall Street that “cash is king.” When it comes to managing personal finance, the saying rings particularly true, especially for professionals and affluent families. That’s because cash is the lifeblood of any financial plan. It’s so important that, here at Jurnex, the second step to any investment plan is how to manage cash flow.
What is cash flow?
Cash flow (also spelled cashflow) is a term typically reserved for businesses. It’s a measure of money coming in and going out over a given period. Cashflow is different from profit and loss, which measures theoretical accounting profits. The two often move hand-in-hand, but not always. For example, if a profitable company fails to manage its cash resources, it could find itself going bankrupt when large loans come due.
Managing cash flow means taking control of this stream. Businesses do this all the time by stretching out accounts payable and collecting accounts receivable.
You can manage personal cash flow too.
When it comes to personal finance, the same principals apply. That’s because everyone’s financial life can be broken down into a series of cash inflows and outflows that can be timed and controlled to a large degree.
Many professionals view their cash flow as static because their salary tends to be quite stable. But there’s far more to income than just salary. Dividends, rental income, and consulting revenue can all add to incoming cash. Even stay-at-home parents can do part-time work for extra income.
Expenses are also controllable in the long-run. Your housing expenses, for example, are entirely dependent on your choice of mortgage size, interest rate, and duration.
Why manage cash flow?
Managing your cash is critical for your financial success. That’s because your cash generation and usage will ultimately determine the amount you can save, spend, and invest.
1. Cash flow positive companies don’t go bankrupt
Cash is the lifeblood of any business. That’s because, while companies can survive without any physical assets, they can’t live without cash. Even companies with plenty of holdings can go bankrupt if their cash flow turns negative enough.
Personal finance operates the same way. Imagine owning a real estate property with a very high mortgage attached. 8%, for example. Even if you have positive equity in the building, you’ll have to cover rental shortfalls with your income.
Someone looking only at assets and liabilities won’t see a problem.
But if you have the mindset of managing cash flow, you’ll immediately see a big issue. The real estate property is money-losing! You would know to refinance the mortgage at a lower rate, or sell the building and put the cash into an income-generating investment.
2. Cash flow is a universal concept.
No matter if you are a high earner, retiree, or teaching your kids finance, cash flow is a universal concept that works for anyone.
That’s because cash flow management looks at both inflows and outflows.
Professionals. Balancing cash inflows from salary, consulting, and investments with cash outflows from personal expenses and contributions to savings.
Retirees. Matching income from social security, dividends, and portfolio liquidation with personal expenses to make sure savings last through retirement.
Children. Weighing between student loan deferment or other financing options with overall liquidity.
What about budgeting?
Budgeting can be an excellent tool for people with fixed incomes. However, most affluent and professional families have significant influence over their lifetime earnings.
Well-off retirees face also face a similar situation. While social security provides a fixed income, retirees can influence their cash incomes by altering their savings draw-down rates.
That’s why cash flow management is a stronger tool than budgeting. Both look towards the same outcome: have your spending fit with your income. But cash management will view outflows relative to inflows.
3. Good cash flow provides peace of mind
It’s critical to have enough cash liquidity. Without it, stress quickly follows.
Money is the number one cause of stress among Americans, according to 44% of respondents. That’s hardly surprising, given 70% of Americans have dipped into their savings at least once in the past-2 years.
Even affluent families can feel the pinch when cash usage doesn’t go to plan. 33% of people have borrowed from their 401(k) plans at some point.
By adequately managing cash flow and having a sufficient emergency cash account, we vastly reduce the problems of running out of cash.
How to manage cash flow
We can break cash flow down into two parts: inflow and outflow
Know how much you’re making, and how much influence you have on its amount and timing.
Understand where your cash is coming in.
Many professional families have multiple sources of income. While salary may contribute a significant portion, people often forget about rental and consulting income until they do their taxes.
Understand the timing
Especially true if you own your business or have real estate investments. The choice of when you pay yourself can matter much. Waiting until the end of the quarter to receive a consultant salary can mean the difference of tens of thousands of dollars.
On the other hand, pulling income forward can give you a lot more cash breathing room. Having your tenants pay at the beginning of the month instead of the end will provide you with an additional month’s rent in the bank.
With expenses, I tend to recommend that people focus on the most important items. Housing, transportation, food, and tuition can easily account for 50% of a family’s expenses. And in the long run, these cash outflows tend to be entirely controllable.
Understand where your cash is going
Families are often surprised to find that small expenses don’t add up to as much as they think. If you start becoming hyper-focused on a particular item, do the math. For example, even if you spend $10 a day on coffee, a $3,650 annual coffee budget seems small in comparison to housing costs, which can easily be 20x that amount.
I generally recommend people make a list of their ten most substantial expenses by merchant and compare it to their overall spending. If you can account for 70-80% of your expenses, you’re on the right track.
Understand the timing
Just like music, timing is everything when it comes to cash flow. The decision to lease or buy a car, rent, or buy a house, or do a lump-sum vs. monthly tuition payment plan will all significantly impact your cash.
How to manage your cash flow
There are several strategies to manage your cash flow. Depending on your situation, any of these options can help.
1. Match cash flows
By bucketing individual incomes and expenses, it’s easy to create a balanced cash flow plan.
Real estate investments are great examples of bucketing. Does the cash from a real estate investment cover its mortgage?
You can also use bucketing in dual-income families. One spouse’s income might be used for all essential items, while the other spouse’s income funds retirement and travel plans.
2. Manage expenses
To manage expenses, I typically recommend clients use the 50-15-5 rule.
- 50% of income goes to essential items, such as housing, utilities, food, tuition, and apparel
- 15% of income goes to long-term savings
- 5% of income gets saved as cash for emergencies
You can spend the remaining 30% however you like.
I like the 50-15-5 rule because budgeting can be tricky. It’s hard to keep track of every expense, and so broad brushstrokes often work best.
3. Use cash flow planning software
Rather than assume a particular outcome, this type of software models thousands of possible scenarios to see the probability of success.
This method is particularly useful for retirees who want to make sure their savings last through retirement.
Typically, financial advisors will have access to this type of software. Some online-only advisors also offer free tools with their services.
If this seems like a lot of information, don’t worry. The great news is that help is available. That’s because here at Jurnex, we work with individuals and families just like you to make the most out of investing. I’ve helped invest client money for over a decade in the same old-fashioned way. And that’s to seek out great companies in great industries that can you can buy at a discount to their fair value. Sounds too simple to be true? Give me a call today, and I’ll show you that it’s still possible after all these years.
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