Friday, September 16, 2011

'Are You Ready?' - Understanding & Starting Cash Flow Management

We all heard how important managing cash flow is. In business, if cash flow management is not up to par, it'll lead to bankruptcy even though it has a strong balance sheet and income statement. Cash flow is the life blood of business, and so it is also the life blood of individuals. It is really just about tracking each drop of cash that comes in and out of your bank account so that you know where the cash flows to at the end of each month or each accounting period that you decide.
How to begin, one may ask. I think the very first thing you need to do is to begin tracking the cash that flows out of your pocket every day for a month. If you can have the discipline to do so for around 4 months, you'll get a good picture of what your baseline expenses are. Baseline expenses are what you have to spend on things that are necessary, like food, housing loans, pocket money for kids and parents, bills and so on. Those are the fixed expenses, as opposed to discretionary spending like the occasional gadgets, a new TV or a holiday trip. Discretionary spending is, well, discretionary, so they are variable by nature. It doesn't occur every month, or at least, they shouldn't.
If you sum up your variable, discretionary expenses with the fixed, baseline expenses, you'll get the total expenses for that particular month. It sounds easy, but it requires a lot of discipline to actually track and record every transaction you make. Try it, and see if you can last a week. I think everyone can have the discipline to do this, it's just whether you are properly motivated or not. If you don't see the point of doing so, then you won't be motivated to do it. As for me, I've been tracking my expenses of 3-4 year now. I started off wanting to do it for 1 month only, but it gets kind of fun knowing exactly where my cash flows to at the end of the month, so I carried on doing so. Now, I can tell you a very good estimate of how much I spend per month.
That figure is one of the aims of tracking your expenses. If you know how much you earn per month, and you know how much you spend per month, you can tell if you have positive or negative cashflow. Positive cashflow occurs when you take in more money than when you spend them i.e. cash inflow is greater than cash outflow. Negative cashflow, on the other hand, occurs when you spend more money than what you take in i.e. cash outflow is greater than cash inflow. It is obviously better to have months in a year where you have positive cashflow.
The only way in which you can have a positive cashflow is to spend less than what you earn monthly. There are no two ways about this. Assuming that you have positive cashflow, so where do the difference between the cash inflow and cash outflow go to? It becomes your savings! It is only when you are disciplined enough to control your expenses below your earnings that you are able to save up every month from your take home pay. If your expenses are 50% of your earnings, then you will save 50% every month. If you spend 80% of your earnings, then you will save only 20% every month. What you do not spend is yours to keep, so try to keep at least 10% of your monthly take home income. If you manage to do that, for every $1 that you earn, 10 cents will be yours to keep!
It's important to have a healthy saving habit. This cash is important to kick start a lot of programs that are beneficial to you downstream. Without this stream of cash that comes upstream, you will have to work forever just so that you can live each month paycheck to paycheck. The good thing about savings is that you can use this to do 3 important things: Emergency funds, Insurance and Investment. The first, emergency funds are used to deal with immediate life changes like retrenchment, medical fees (the initial cash component that is not paid immediately by insurance) or a punctured tire. The second, insurance, is meant for protection against the loss of life, limb, health conditions and the ability to carry on making an income that generates the cash inflow in the first place. The last, investment, is meant to grow your savings into a bigger sum so that you can achieve the financial goals of your life.

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