One of the more powerful concepts to understand in the matter of personal finance is cash flow. Most of us can easily tell the difference between being confident & comfortable with our finances versus struggling with our finances. Unfortunately, many people do not truly understand cash flow, nor do they grasp the crucial role it plays in regard to their own personal finances. When you understand the concept of cash flow and can then work to improve it… you give yourself tremendous flexibility which will undoubtedly bring to light many otherwise indiscernible opportunities.
What is cash flow?
Cash flow is basically your income minus your expenses. If your income is about the same as your expenses, you’re living paycheck-to-paycheck. If your income is higher, you’re financially okay. And if your income is lower, you’re accumulating debt. Very simple isn’t it?
And here is the beautiful part. Once you understand the basic components — income and expenses — you can begin to take concrete actions to improve your finances. And you can break down the problem even further by looking at reducing individual expenses and improving your income.
How to improve your cash flow
Reduce your expenses
The quickest way to improve your cash flow is by attacking your expenses; especially the recurring month-to-month type. The biggest bang for your buck is your mortgage, if you have one. Take a look at today’s best mortgage rates and see if it makes sense for you to refinance. Refinancing alone could free up several hundred dollars that you could use for other financial endeavors.
This process of expense reduction is even easier if you are already keeping a budget. If you don’t have one, you should start tracking your expenses and start work to create one. The key to success in expense reduction is doing all the little things that add up and trying to take one small step at a time. Don’t try to reduce your expenses by 50% — it will never happen. Challenge yourself to cut $50 a month or a $100 a month. Once you accomplish that, go for another $50, and so forth.
Increase your income
The other side of the equation is improving your income. This is harder than cutting your expenses, but there are things that you could do — even little things like moving your money to a high interest savings account helps you to earn more. Again, it’s all the little things that add up.
What about a other income ideas? You can basically break them down into a few categories:
- Earn more from your job — i.e., ask for a raise, get a promotion, work overtime, etc.
- Earn more outside your job. Here are a few additional income ideas for you to mull over.
- Make your money work harder — i.e., investing in the stock market, real estate investing, and other alternative investments, etc.
What to do with your free cash
So you’ve improved your cash flow, what should you do with the extra cash? Here are a few ideas:
- Pay down your debt — e.g., credit card debt reduction, car loan, student loan, etc. As you do this, you’ll free up even more cash because you no longer have to pay all the finance charges and monthly payments.
- Invest your money. Again, make your money work for you and continue to improve your cash flow.
- Give. If you are in a position to give, charitable donation is also a great way to use your money.
I hope you enjoyed this article, and more importantly, I hope you walk away with a few ideas you can use to improve your finances.
Pinyo is the owner and primary author of Moolanomy Personal Finance blog. Moolanomy focuses on practical money management concepts, personal finance tips, and wealth building. If you like this article, please visit his blog. Lastly, you can leave financial question on Moolanomy Answers where Pinyo and other community members participate to provide you with answers.
Paul @ FiscalGeek says
Great post Pinyo
Thanks Paul. I appreciate the feedback. 🙂
Steve in W MA says
Not to be overly pedantic, but cash flow is properly understood as the inflow and outflow of cash *over a specific period of time*.
It’s very possible to have higher income than expenses during the year, but the have a cash flow problem at some point of the year because total current expenses are higher than total current available cash. Usually the way to avoid this kind of problem is to accumulate funds (sinking funds) to get you through the period of time in question.
A good example of this is tax time: if you have to pay out a lot of money in taxes in a particular month, you can have a cash flow problem because your current amount of monthly income is not enough to cover the taxes plus your other expenses. Hence the reason people save up for these tax expenses (make sinking funds to cover them) throughout the entire year.
Matt Jabs says
We use sinking funds for all fixed, non-monthly expenses and it works great.
I think the only way that you can improve cash flow after a certain point is to invest your money. You can only cut expenses so much, and you can only work so much overtime. Investing income into index funds, bonds, real estate, internet properties, dividend stocks, etc. over the long term is the only way that i can see cash flow increasing over a long period of time. I think if you adopt this mindset early, retirement will come early 😉
Matt Jabs says
Both are necessary steps.
Richard Brown says
Very nice article. Sometimes all it takes to become wealthy is getting out of debt, spending less than you make and investing your money wisely.
Mary Kaplan says
Good post. The comments you made about creating and sticking to a budget are right on. Many people run into problems because they do not really understand how they are spending their money. Understanding how the cash flows out can provide the insight required to make changes. Wise investing is a great way to get more money coming in.