There are many ways to measure your financial health. The measurement that probably gets the most attention from personal finance books and news outlets is the personal balance sheet, or net worth statement. Knowing your net worth can be important, but keep in mind that it is a snapshot in time and not necessarily a true indicator of financial health. There are many other factors that affect your financial health, one of which is your cash flow statement, which is a representation of your net monthly cash flow.
You can use your cash flow statement in conjunction with your net worth statement to get a better idea of your overall financial health. Later we will show you how to combine your net worth statement and cash flow statement with a financial risk test and debt analysis which will help you get a more clear picture of your financial health.
Positive Cash Flow is the Building Block of Wealth
One of the fundamental building blocks of becoming wealthy is spending less than you earn. It is one of the core concepts of achieving wealth. Your cash flow statement won’t tell you if you will become a millionaire or not, but it can tell you if you are on the right path – hint: you can’t build wealth if you are running on a deficit.
This is why it’s essential to know where your money is coming from, and where it is going. You should also know when all of this is happening. Cash flow management in your personal finances is important, since it keeps you from overdrawing your account and helps you plan ahead for larger expenses. When you know how money flows through your personal economy, you are in control.
How to Create a Personal Cash Flow Statement
Creating a cash flow statement may remind you of creating a budget. You will need to record all sources of income and all your expenses. Then you will add the final amounts for income and expenses. Just like your net worth statement, a positive number is positive cash flow (good!) and a negative number is negative cash flow (bad!).
Understanding Your Cash Flow – the When, Where, and Why
If you want to get an idea of how money is moving in your personal finances, the first thing you need to do is keep track of everything:
- Note your income. Find out when you are paid. This is about more than just recognizing your monthly income. You should know when each pay day is (the first of the month, or every other Friday, etc.), and how much you will receive each time you are paid.
- Track your expenses. Next, you should know where your money is going, and when it needs to get there. Figure out how much is going into your retirement account, emergency savings and for bills. Check to see when your regular bills are due, so you know when that money will be needed.
Knowing where your money is coming from, how much of it is spoken for, and when it needs to be taken care of, is very important. If you do not have an idea of how your money is moving through your personal economy, it is much easier to make mistakes—and you could find yourself overdrawing your account and perhaps not having the money you need to meet your obligations.
Factors to Consider in Personal Cash Flow Statement
Account for regular and irregular income. A cash flow statement is designed to list all sources of income that affect your cash flow, not just your salary from your day job. Below this section is a list of income streams to consider adding to your cash flow statement. However, you should only add the income sources that are available for spending. For example, investment income and dividends are listed as forms of income, but you wouldn’t list those on your cash flow statement if they are in retirement accounts or are automatically reinvested. Dividends are also unique, in that many pay out quarterly or semi-annually. So you will want to note that on your projections if you rely upon dividend investments for cash flow.
Track both regular and irregular expenses. On the same token, you need to record all expenses, including regular and irregular expenses. For example, some of your expenses, such as insurance, may come quarterly, semi-annually, or annually. You may wish to break those down into a monthly approximation (examples could include insurance premiums, taxes, homeowner’s association fees, investment contributions, etc.). Groceries and utilities are also expenses that can be approximated to smooth out your cash flow statement.
The following is a list of income sources and expenses that you may wish to include in your personal cash flow statement. You will need to tailor it to your needs.
Common Types of Income
- Salary 1
- Salary 2
- Self-employment income
- Freelance/consulting income
- Government benefits (unemployment, Social Security Disability benefits, VA disability benefits, welfare, etc.).
- Child support/alimony
- Investment Income
- Interest income
- Capital gains
- Social Security Retirement Benefits
- Annuity payments
- Retirement plan distributions (401K, IRA, withdrawals)
- Car payments
- Insurance premiums
- Property Taxes
- Alimony/Child Support
- Investment contributions
- Estimated taxes
- Medical care
- Dining out
- Maintenance/home or auto
- Spending money
Calculate the Net Cash Flow and Adjust Your Budget
Add total income and expenses and you have a personal cash flow statement. If your cash flow statement is positive, then you have some additional cash each month that you can use to help you reach your financial goals (build emergency fund, pay down debt, invest, etc.). If your cash flow statement is negative, then it is time to look for ways to right the ship and turn things around. Look for areas you can trim back on expenses, and ways to increase income.
You may be able to project your income and expenses for several months. Take care to notice any upcoming big ticket items or irregular expenses, and plan accordingly.
Once you understand how your money is moving through your personal finances, you can begin to make changes to the way things are done. For example, you may find that most of your income is irregular. This is common when first starting a career in freelancing, starting a small business, and in certain types of jobs.
It’s important to pay your bills when they are due, and not try to get too far ahead of yourself if things are tight. That way you don’t spend all the money you need for living expenses for the next couple weeks on a bill that isn’t due for another month. It can take a balancing act, but it’s worth going through this exercise to avoid overdraft fees, bounced checks, late payment penalties, or cutting back in other areas.
Creating a cash flow statement, and using it, can do wonders for your financial health.