The Importance of Properly Managing Your Cash Flow

Creating a positive cash flow can help you exponentially grow your wealth. As the saying goes, “The rich keeping getting richer,” but that’s because the rich are cash flow kings: they use cash to create more cash flow. The more cash they have, the more cash flow they can create.

To achieve this, it is important to understand why cash flow is king, what cash flow is, why it matters and the biggest problems that exist for both cash and cash flow.

What Is Cash Flow?

Cash flow is simply the difference between the amount of money that comes in every month and the amount of money that goes out. (For more, see: How Much Cash Should I Keep in the Bank?)

Positive cash flow would mean you make more than you spend. Positive cash flow is by far the best indicator of a person’s ability to live within their means and their long-term capacity to build wealth. The more money you have left over every month after all your expenses mean the more money that can be put towards creating even more cash flow now or in the future.

Why Does It Matter?

Cash flow is the proverbial fuel for our fire with everything we do financially. In order to keep a roof over our heads, put food on the table, pay down debts, save for retirement, and have the freedom to pursue the experiences we enjoy, we need positive cash flow month after month.

If you're always behind on bills or never have any money left over every month, it’s impossible to get ahead. In order to increase your cash flow, you need to either lower your living expenses or increase your income, or do both of these things.

The Biggest Problem With Cash

We get paid in cash and we use it to pay for everything we pursue in life. Bringing in cash is obviously a good thing, but sitting on too much cash isn’t. Cash’s value erodes over time if it’s growth isn’t able to keep up with inflation. Low interest rate environments are deadly times for sitting on large amounts of cash.

As a current day example, most retail banks still pay very low interest rates on cash savings. If the most you could earn on cash in a savings account is 1% while inflation hovers at 2-3%, your cash’s purchasing power is eroded. In order to build wealth, it’s imperative that our investments, at the very least, keep up with inflation over long periods of time. So, we invest our cash in various ways, whether it’s in stocks and bonds, real estate, other businesses, or anything else capable of creating growth and cash flow. (For more, see: How Inflation Affects Your Cash Savings.)

The only cash you should hold onto long term is an emergency fund (as a buffer against unexpected expenses) and enough for a month or so of everyday living expenses that you keep in a checking account.

The Biggest Problem With Cash Flow

There is no direct problem with cash flow itself. However, people frequently fall victim to the lifestyle creep. This is when someone starts making a lot of money, but spends everything they make.

What often happens that they find themselves in a large amount of debt, which only spreads the fire. All their cash flow is consumed in servicing that debt and all other expenses that feed their lifestyle. Before you know it, they’re spending money just as fast as they can make it, never able to save or invest to provide for themselves in their future.

On the bright side, however, learning to harness cash flow is easier than you might imagine. It is possible to break free of that unrelenting stress of trying to get out of debt and barely scraping by.

Financial freedom comes first from mastering your cash flow. Cash flow kings are capable of building the foundation of empires from this skill alone.

How to Be a Cash Flow King

Most of us make a fixed amount of money every month. We’re likely paid a set salary and can expect a certain amount of money to be deposited to our bank account every two weeks. The bright side of this is that it makes it easy to build a budget. The hard part is sticking to that budget.

Many of us have a hard time managing our monthly cash flow. We haven’t figured out how to prioritize our expenses and create a system that can manage them. The easiest system to manage all this is to break your spending into three separate buckets, each with their own account(s):

  • Fixed expenses: rent/mortgage, utilities, loan payments, etc. This should go in your main checking account.
  • Discretionary expenses: groceries, dining out, travel, entertainment, etc. This should go into a separate checking account just for these expenses.
  • Savings/Investments: emergency fund, down payment fund, retirement accounts, etc. Put any cash savings in a high-yield savings account.

After you’ve sorted out how much you can afford or need to allocate to each bucket, set up automatic transfers from your main checking account where you receive your paychecks. Here’s a quick example:

If your discretionary expenses budget is $150 per week ($600 per month) and your emergency fund monthly savings goal is $1,000 per month, the solution is to have a weekly transfer of $150 from the main checking account to the discretionary checking account and spend your budget from there and to have a monthly transfer of $1,000 from the main checking to a high-yield savings account.

To make it even easier, you could have these transfers occur the same day you get paid. This way, you can’t spend more than you’ve allocated for discretionary expenses, you’re making saving and living within your means a priority, and you're eliminating much of the fuss that often happens when trying to stick to any particular budget.

The easier you make your cash flow to manage, the more likely you’ll adhere to it long term. The more you adhere to it long term, the better the results will be. (For more from this author, see: 5 Ways You Can Be More Financially Responsible.)