The Simplicity of Cash Flow

What is cash flow?

Income – Expenses = Cash Flow

It’s the calculation of how much money is coming in and how much money is being spent.

It can actually be pretty simple. Take the time to learn more about it, and it could make your life a lot easier!

I’ll show you in this article, step-by-step, how to establish your cash flow and ways to make it better, and with a lot of examples!1

Which cash flow example looks closest to yours?

Example of Neutral Cash Flow
Income $5,000/mo
Expenses $5,000/mo
Cash Flow $0/mo
Paycheck to paycheck.

Example of Negative Cash Flow
Income $5,000/mo
Expenses $5,500/mo
Cash Flow -$500/mo
Overspending and going into debt.

Example of Positive Cash Flow
Income $5,000
Expenses $2,500
Cash Flow $2,500
Good management of money with expenses at 50% of income.

How are you feeling?
Proud, stressed or indifferent?

Regardless, continue reading to understand this subject more and see how you can improve it!

Step 1: Know your Income

If you don’t already know, find out your current monthly income.

Look at your Gross Income (before taxes and deductions) and your Net Income (after taxes and deductions, this is what you actually receive in your bank account)

Deductions are things like health insurance premiums, 401k/retirement contributions, etc. You will see these kind of things on your paystub if you receive these kind of things.

It’s good to know both Gross and Net Income, however, you’ll likely be thinking mostly with Net Income because it is easier to calculate and work with.

Step 2: Know your Expenses

You have to know where all your money is going to understand how your cash flow is doing. Unfortunately, it is not something you can just “wing it”. From my experience, and many would agree, it is very easy to overspend without realizing it!

List out all your monthly expenses, every last one!

Then these monthly expenses should be sorted by importance. We call them Needs and Wants.

Examples of Needs (Required to Survive):

  • Mortgage/Rent
  • Food
  • Utilities

Examples of Wants (Not Required to Survive):

  • Streaming services (Netflix, Hulu, etc.)
  • Vacations
  • Dining out
  • Entertainment

Note: If you’re using Net Income, make sure you are not counting your taxes and deductions from your paycheck twice.

Now you should have all your expenses for your Needs and Wants, so add that all up to get your total monthly expenses.

Step 3: Establish your current Cash Flow

Now put your total monthly income then subtract your total monthly expenses from it. (Income – Expenses = Cash Flow)

If your expenses are lower than your income, you will get a positive number and thus a positive cash flow. This means you’re doing something right!

If the expenses are higher than your income, you will get a negative number and thus a negative cash flow. This means you’re overspending and may be going into debt (if you’re borrowing money to survive).

How to Fix a Negative Cash Flow

There are two ways to handle the negative cash flow:
1. Reduce your expenses
2. Increase your income

What to do when your expenses are too high
Evaluate your Wants, see what you can live without or reduce such as:

  • Dining out
  • Coffee
  • Online Shopping
  • Gifts

What to do when you can’t reduce your expenses any further
The only logical answer is increasing your income, which I cover this in my Ideas on How to Increase your Income article.
It is worth noting, when you do successfully increase your income, avoid raising your expenses too!

This all may take some adjusting. But achieving a positive cash flow is a very good thing, not only for your financial health but for your own quality of life!

So make it a top-priority to reach and remain positive in your cash flow.

Step 4: Create Separate Accounts for your Needs and Wants

Once you’ve established your Cash Flow, there is another step you could take that may help stabilize your positive cash flow if you have a challenge with consistency.

You can take the extra precaution against overspending by using two separate accounts for all your expenses, each for your Needs and Wants.

Example: The Needs Account

For all your expenses that are Needs it should come from an account specific to that, we’ll call it the Needs Account.

The Needs Account ensures that you have the funds for your most important bills.

Let’s say $2,500 a month is required for needs. So if you get paid weekly, put $625 from each paycheck into Needs Account, so that every month you’ll have the money to pay for your most important expenses.

Example: The Spending Account

For all your expenses that are Wants it should also come from an account specific to that, we’ll call it the Spending Account.

The Spending Account ensures you don’t go over your spending limit (this also means do not borrow for wants)

Let’s say $2,500 monthly is what you want as a spending limit, that means you can also put $625 per check into that Spending Account.

By doing all this, you’ll also be more aware when funds run out in either account.

Now these are just examples to keep the math simple, but it’s important to remember to save as well! I cover this in more detail in The 50/30/20 Rule, Budgeting Made Easy article.

Summary

In a nutshell:

  • Know your income
  • Know your expenses
  • Know the needs vs the wants
  • Do not spend more than you make
  • Use a workable system for yourself that prevents overspending

No matter what, these rules apply to any income level.

  1. For education purposes only. This is not financial, legal or tax advice. Consult the appropriate professional before implementing a strategy to make sure you find the right solution for your specific needs. ↩︎

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