December 8, 2020
Businesses regularly publish important financial documents that show their financial health and success. One of these is a cash flow statement, which shows the ins and outs of actual cash during a given time period. Cash flow is an often-ignored part of managing a budget that many businesses and people fail to take into account. It’s easy to assume that the money going out on a monthly basis is less than the money coming in, but do you know for sure that’s true 100% of the time?
For businesses, monitoring cash flow is often a requirement to meet debt obligations and fund future projects. For individuals, it’s not much different. Monitoring your cash flow will lead to tackling your debt with more power, stop living paycheck to paycheck, be ready for emergencies, and save for future purchases and goals. Let’s keep the analogy going and explore how you can manage your family’s cash flow like a business:
A cash flow statement usually has 3 sections: cash flow from operations, cash flow from investing, and cash flow from financing. A cash flow statement isn’t exactly like a budget, but it does help you plan your budget and any variances from it.
‘Operations’ are the day to day activities of a business, so a cash flow from operations simply refers to the money amassed from regular work and spent on regular expenses. Your family’s cash flow from operations may include:
Once you have the sum total, subtract out the money that you and your family spent. This includes discretionary expenses like gifts, date nights, home decor – even if you put those expenses on a credit card. It would also include the boring stuff like insurance premiums, rent payments and utility bills. Just don’t include debt repayments — those go in a different section.
For a business, investing activities are purchases or sales of assets, loans made to suppliers or received from customers, and payments related to mergers and acquisitions. We’ll change this definition a bit to suit individual and personal cash flow statements. There will be two sections:
Positive cash flows from investing: This is money that you would pull out of any of your investment accounts. If you’re retired, it would include any monthly withdrawals you make.
Negative cash flows from investing. This will include any money you put into investments for the future. This frequently consists of retirement savings, 529 contributions, contributions, real estate purchases, etc.
Note that in this section, having a net negative cash flow would actually be a good thing. It’s a little counter intuitive, but you should actually aim for a negative cash flow from investing balance.
For a business, financing activities include the inflow of cash from investors, such as banks and shareholders and the outflow of cash to shareholders and lenders.
Positive cash flows from financing: someone pays you back for a multi-period loan you made to them.
Negative cash flows from financing: paying for a mortgage, car loan, student loans, and prior credit card debt.
A cash flow statement allows businesses (and people) to get a clearer idea of their financial health. If you add up the three sections of a cash flow statement, you’ll quickly see if your net cash outflows are more than your cash inflows. But by breaking the information into operations, investing, and financing sections, you will eliminate any financial blind spots you may previously have had. For example, if the biggest reason your cash flow statement is negative is the cash flow from operations section, you will know to focus on increasing your income or decreasing your daily expenses. However, if the biggest contributor to a negative balance is the cash flow from financing section, you might have picked a car that’s too expensive for your current financial situation, or you might have to look into income-based repayment plans for student loans.