The power of positive cash flow

5 things that undermine automating your finances - cash flow - 600

When I lived paycheck-to-paycheck, there never seemed to be enough money to go around. I was perpetually $50 or $100 short of what I needed. Because I was spending more than I earned, I fell further behind every month. I had a negative cash flow, which led to more debt, which put me deeper in the hole.

It is mathematically impossible to get ahead with a negative cash flow — in order to save money, in order to pay off debt, you must earn more than you spend. Though I understood this intellectually, it was only when I actually saw the concept applied to my own life that I appreciated the power of positive cash flow.

Cash Flow Basics

To gain wealth, you must spend less than you earn. This is the fundamental law of money. Framed in terms of a mathematical equation:

[WEALTH] = [WHAT YOU EARN] – [WHAT YOU SPEND]

This formula tells us two things:

  • If you spend more than you earn, you are losing wealth — you have a negative cash flow.
  • If you spend less than you earn, you are accumulating wealth — you have a positive cash flow.

The greater the gap between earning and spending, the faster you lose (or accumulate) wealth. There are only two things you can do to increase your cash flow: spend less or earn more. (Or both!) This seems obvious, I know, but smart personal finance really is this simple. Everything else — paying yourself first, investing ten percent of what you make, building an emergency fund — is done in support of this fundamental law.

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. — Charles Dickens, David Copperfield

How to Improve Your Cash Flow

Most people can improve their cash flow right now with minimal effort simply by spending less. If you're looking to make a change, practice frugality: buy used instead of new, make the things you own last longer, recycle worn-out goods for other uses. Look for cheaper options on the things you buy and do every day.

It's useful to change your mindset to focus on needs, not wants. Many of the things that we've come to view as necessities are actually luxuries. You don't need 180 cable channels or a Netflix subscription. You don't need a cell phone. People lived without these things for centuries — it's still possible to live without them.

Recurring expenses can be especially insidious. Long-term contracts and installment plans often contribute heavily to negative cash flow. If you truly need to make a major purchase, save the money to pay in full. Don't buy things you cannot afford.

If you can't (or won't) decrease your spending, then you'll need to find ways to increase your earning. If your current job doesn't pay well, try to find another. If you like your employer, you might work to earn a promotion or ask for a raise. Also look for ways to make money from your hobbies. Finally, don't forget that you can sell things you no longer want or need.

Related >> Use Your Hobbies to Bring You Wealth

Two other skills can play crucial roles in managing your cash flow. First, you should learn to track every penny you spend. If you don't know how much you're bringing in or where it's going, you cannot know where changes need to be made. Also, many people consider a budget an important planning tool. With a budget, you can be certain that your money is being put to the best use.

As your income grows and your spending shrinks, your cash flow will increase. At first you might have just a little extra cash each month. Using the principles of the debt snowflake and the debt snowball, you can use this money to pay off your credit cards, your car loan, and other consumer debt. You might make minimum payments at first, but eventually you'll be able to pay an extra $25 per month, then maybe an extra $100, or even $250. As your cash flow increases, you may be amazed to discover how quickly you can pay off your debt!

A Hypothetical Example

Joe Spendsalot has been living paycheck-to-paycheck, making minimum payments on his $5,000 credit card debt.

  • Joe brings in $2,500/month after taxes. He also spends $2,500/month, including $100/month to his credit card bill, which barely covers the interest. Because he spends as much as he earns, Joe's cash flow is zero.

Running the numbers, Joe realizes it'll take him decades to pay off the credit card. He decides to increase his cash flow by taking a part-time job at the local comic book store, where he earns an extra $250 per month. At the same time, he cancels his cell phone, begins cooking more meals at home, and switches to store-brand groceries. This saves him $250 per month.

  • Joe is now bringing in $2,750 per month after taxes. He spends $2,250 per month. He has a positive cash flow of $500! It's now possible for him to pay off his credit card within a year.

Once Joe has eliminated his credit card debt, he will have freed up an additional $100/month, raising his cash flow to $600. (If he's smart, he'll begin saving and investing this money.)

The Power of Positive Cash Flow

When I started my financial turnaround in the fall of 2004, I had $35,000 in debt. It took me just over three years to eliminate this. Simple math reveals that I obtained an average positive cash flow of $1,000 per month.

This didn't happen all at once, though. I started at zero, just like everyone else. In fact, early in 2004, I still had a negative cash flow. By October, I was bringing in about $50 more than I was spending. I was making minimum payments on my debt, but looking for ways to increase my income and decrease my spending:

  • I began to practice frugality in earnest.
  • I sold stuff I no longer wanted or needed via Amazon and eBay. I also sold stuff on Craigslist and at garage sales.
  • I looked for other ways to increase my income through photography and writing.
  • I re-evaluated my spending. I paid particular attention to recurring expenses. (I cut back to basic cable, for example, which saved me $50/month. That's $50/month of positive cash flow created instantaneously.)

Alone, each choice contributed only a little to my bottom line, but taken together, they made a huge difference. And once I saw the power of positive cash flow, it gave me confidence to continue, even when there were other things I'd rather do with the money. (In the past, having a few hundred dollars extra per month would have been license for me to buy a new car or to find an expensive hobby.)

Now that my debt has been eliminated, I've directed this positive cash flow to saving and investing. As exciting as it was to repay debt, it's even more thrilling for me to build wealth. I'm able to do this quickly with a positive cash flow of over $1,000 per month. And I accomplished all this by using the principles I write about daily at Get Rich Slowly.

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Cornelius
Cornelius
12 years ago

I agree that needs are more important than wants. Wants are what have people in debt strife that they are in.

Saving the money to pay in full was how they USED to do it.

J.D you have produced a good example of how to get into a positive cash flow.
Cheers..

fathersez
fathersez
12 years ago

Cash is king is not a statement that has been lightly said.

Even investors gauge investments by studying the target companies’ cash flow statments.

You have made a great point in pointing out the similarities to pur own pf health.

Adam
Adam
12 years ago

Excellent article, and so true. It’s sometimes difficult to keep your out goings less than your income each month, but one thing we’ve found which really helps with budgeting is creating a savings account for all those big yearly bills. We tot up the total, divide by 12, and save that amount each month in a savings account. For some reason, February is usually an expensive month for us (house and car insurance due), but these days it’s simply a case of transfering the money back from out “annual bills” saving account. It’s also an excellent way of building up… Read more »

SingleGuyMoney
SingleGuyMoney
12 years ago

I couldn’t agree more. By paying off my credit cards, I’ve freed up more cash for savings, investments and paying off installment debt. I will be paying off my car loan soon and this will increase my cash flow even more.

NoDebtPlan
NoDebtPlan
12 years ago

If people could get this one concept, everything would be so much easier. Cash flow is key!

KC
KC
12 years ago

You are dead on about the recurring expenses – they will eat you alive. Think about cable, cell phone, house phone, netflix, TiVo, gym memberships, security systems, maid, yard person, bank fees and many more. Those take a bite out of your check before you even get it. In the same vein so do your house payment and car payment. So it’s best to keep them low (don’t buy more house or car than you can afford). Without all these drains on your paycheck YOU can actually determine where YOUR money goes. disclaimer – I do have netflix, cable and… Read more »

Sandy
Sandy
12 years ago

That’s wonderful that you had the determination and discipline to wipe-out $35,000 of debt in 3 years! That has to be an inspiration for others, that there is a light at the end of the tunnel when you can finally give those payments to yourself to build wealth, and no longer to creditors. You stopped a habit of overspending for 3 years, and replaced that w/a frugal lifestyle habit. Living within our means was a given when I was in my early 20’s because there weren’t charge cards then! Can you imagine? We had to save up for everything and… Read more »

J.D.
J.D.
12 years ago

KC makes a good point. I think some recurring expenses are fine — even necessary — but it’s important to make sure you’re getting value for your dollar. For example, when I was paying $68 for a deluxe cable television package, I was basically throwing money away. I rarely watched TV. I was paying over $800/year for something I didn’t use. DUMB. Now we have basic cable at $13/month. I still don’t watch TV, but Kris is able to catch Antiques Roadshow and her Jane Austen specials. This one move created an extra $600/year. Cutting our land-line freed $30/month. And… Read more »

Anne
Anne
12 years ago

This is kind of a simplistic analysis as it overlooks the power of leveraging debt to increase earnings. I spent three years living well beyond my means because I was at an expensive law school and had no job. But that law degree–and the debt that financed it–bought me an income that’s more than double the sum of my student loans, allowing me to grow my net worth far more rapidly than if I hadn’t gotten a postgraduate degree. Real estate appreciation is also a classic example of leveraging debt to build wealth: if you sell a property for $50,000… Read more »

Steven
Steven
12 years ago

Great article!!!

I, too, enjoy the power of postive cash flow. Microsoft Money has a feature that allows me to track my net worth. I love seeing the numbers increase.

Sandy
Sandy
12 years ago

@Anne – when I wrote about “debt-free”, I specifically meant with charge cards, i.e. Visa, etc. and department stores, but did not say that. You’re right about being too debt-adverse can hinder building wealth. For example, I bought a house in 1995 for $175,000 in CA & in 2005 (height of housing market), sold it for $612,000, so made a profit of $437,000. Had I not gone into debt to purchase the house, that profit from the appreciation never would have happened. Ditto for other investments. It’s just the credit cards that I was making a point, or trying to,… Read more »

Daiko
Daiko
12 years ago

Great overview, JD. When examining negative cash flow, one important area is recurring expenses that cannot be quickly reduced or eliminated: car payments, property taxes, house payments, and rent fall into this category. This subcategory of recurring expenses is what I think of as fixed expenses, and can be key to financial viability. If your fixed expenses equal or exceed your income, you are in real trouble: start looking for alternatives that reduce those fixed expenses as quickly as you can. As hard as it may be, this may include selling the house, selling the car, or finding a new… Read more »

RacerX
RacerX
12 years ago

You really did hit the nail on the head when taking a look at small expenses that add up. When I first brough up downgrading our Direct TV package the whole family screamed. S o I paid attention for 2 weeks to see what they were really watching. With those channels in mind I whacked it to the smallest posible package.

No one noticed!

At our monthly family meeting I brought it up again to cries of pain…then told them it had been gone for a month

Sean H
Sean H
12 years ago

Another great article. What many don’t realize is that it usually only takes a short time of practicing the extreme frugality in order to get back on track. But once you go through the trouble of selling off some personal items once or twice, it becomes a life long lesson. Works great with kids, also. Then, the key is learning a new way of living – a financially sound way!!

Money Blue Book
Money Blue Book
12 years ago

I think cutting back on simple recurring expenses are one of the easiest ways to practice frugal living and to increase one’s ultimate cash flow. Things like cable TV charges, cell phone plans, and even premium coffee habits can be cut back for greater savings. They all require an eye towards sacrifice though..

jtimberman
jtimberman
12 years ago

With regard to television and home entertainment expenses, we saved a heaping ton of money by purchasing an inexpensive ($25) over the air antenna. We have an HDTV with internal tuner, so we can get some HD broadcast digital channels like Fox, NBC and CBS. So for the cost of cable TV setup, I got an antenna. Its indoor, so it doesn’t get everything all the time, but $70 will get us an outdoor antenna if we want a few more channels. I miss out on some of the cable shows I like, such as Mythbusters, South Park, Top Gear,… Read more »

Ron@TheWisdomJournal
12 years ago

The problem we have in this society is that we all want to enjoy the luxurious lifestyles we see on TV. I heard a wise man once say, “Beware of luxuries. A luxury, once sampled, has the tendency to become a necessity.” He’s right. I go over to my wildly successful brother-in-law’s house (one of six houses) and see hiw 60+ inch HDTV and think, “I want HDTV. It just looks so much better.” I don’t need it but I have the tendency to justify it as a “need” because we “need” it when people come over to watch the… Read more »

Eric
Eric
12 years ago

Great blog! Another way of saying positive cash flow is living within your means. The value of this was recently driven home with a pile driver. Last April, I was diagnosed with stage 2 colon cancer. My wife and I have always lived within our means. We have a decent income and have avoided ‘keeping up with the Joneses’. As a result, we have savings and comfortable living expenses. Let me tell you, not having financial worries to go along with my health issues has been HUGE! Thanks to disablility, we have actually been able to stay positive cash flow… Read more »

kick_push
kick_push
12 years ago

^ ^ hey ron.. i think it’s okay to want nice things.. just don’t get the 60 inch hdtv when you can only afford the 40 inch.. ya know?

Adam Snider
Adam Snider
12 years ago

This is very true. I’m still living paycheque-to-paycheque, and I’ve actually had a negative cash flow for a couple of months, which is really scary. Luckily, I’ve managed to start living a lot more frugally, so I’m starting to get back on track…slowly but surely, my financial life is turning around.

Kent Irwin eFinPLAN
Kent Irwin eFinPLAN
12 years ago

This is really good information. I’ve counseled people going through difficult financial times, and most people feel that if they only had a few thousand extra dollars of income their problems would go away. However once they get a raise, their financial picture didn’t really change. I also know people who live modestly, have saved and invested, and now are able to live at a higher standard of living than their peers – many of which have larger incomes. It is not what you make; it is what you spend and save that makes all the difference in the long… Read more »

Jeffeb3
Jeffeb3
12 years ago

Isn’t that equation actually for the change in wealth, and not wealth? Either that or your wealth is equal to the amount you have earned throughout your life – the amount you have spent throughout your life. You need one of those triangles (the greek delta).

allen
allen
12 years ago

While i liked the majority of this article, there was one part that i took exception to:

Cell Phones.

Maybe it’s my age, but that wouldn’t work for people i know. I have Litterally 3 friends who have land-lines, and only 1 of them even checks it. You have to keep in mind that most of us under 30 only use a cell phone. We don’t need or want a land line, thank-you-very-much.

That being said, lowering your plan to a lower tier, canceling your internet-via-cellphone, &c are all still good ideas!

MikeVx
MikeVx
12 years ago

Positive cash flow is definitely worth doing. At the beginning of last year I found this site, from a link on Fark, if I remember correctly, and managed to get my finances into some semblance of non-disaster. This paid off recently when I had an encounter with a fog bank and a deer. The deer didn’t stick around to trade information, so I had to contend with the repair out of my own pocket. 🙂 (After the last insurance disaster, it needs to be very large to be worth dealing with them.) It ate my car repair fund, the emergency… Read more »

Minimum Wage
Minimum Wage
12 years ago

Actually, it’s quite possible to get ahead with negative cash flow if you own an asset (e.g. home, investments) which is appreciating faster than the cash is flowing in the opposite direction.

If you di it with rental properties, you can become quite wealthy.

zach
zach
12 years ago

to those who feel that recurring costs can be the fastest path to positive cash flow, I offer this: my wife and I have nickel and dimed ourselves to the poorhouse on simple things like fast food, coffee, restaurants, etc. Real numbers: $75/month on starbucks food + drinks (averaging $2.50 for the breakfast sandwiches and a small tea)! $20/meal becomes $30/meal with drinks and $40/meal with desserts for two. That’s DOUBLE the original cost of a meal! I can’t tell you how much we’ve saved by eating in, but I *can* tell you how much more happy we are, and… Read more »

David
David
12 years ago

@jtimberman: Missing Top Gear seems a little excessive, so why not take a look at http://www.bbc.co.uk/iplayer. It lets you watch BBC shows from the last week, including Top Gear. Not entirely sure if it works outside the UK, but it’s worth a shot

Sadly, I’m not aware of any online versions of Mythbusters or South Park outside of people uploading to Youtube, Mythbusters in particular is one I would have liked to watch myself.

Matt
Matt
12 years ago

Great post – it took me a great many years to figure out that it’s not about how much money you’re making but how much money you’re spending. If you spend more than you make then you’ll always live from paycheck to paycheck and you’ll find it hard and hard to do so.

Anne
Anne
12 years ago

This is just where I am. More debt than I need right now or ever. I will put these practices to use – can’t wait until my cash flow is positive again.
Thanks for the help.

Mike
Mike
12 years ago

@ David, post 29.

In Canada, at least, if you go to http://www.comedycentral.com you can watch ALL of the South Park Episodes from every season online for free, with no commercials. Not to mention many other shows like Daily Show, Colbert Report, etc.

Robert Brown
Robert Brown
6 years ago

To maintain your cash flow one must have a check on the business budget.Its working capital must in organized in such a way that he should not suffer from any kind of problem regarding finance.invest money in a very positive way.Think twice before investing.Do not flush your money fluently on a such deals which does not lead you towards profit.The formula is very well self explanatory regarding profit the way to analyse how much profit you have earned.The article explains in a very nice way to maintain a positive cash flow.Thanks for the input. 🙂

Robert Brown
Robert Brown
6 years ago

To fully understand a company’s viability as an ongoing concern, an auditor would do well to calculate a few simple ratios from data on the clients cash flow statement.Cash flow helps a company grow its business in the economic marketplace.Companies with strong working capital balances can also avoid external financing, which often includes bank loans that create cash outflows via loan payments.

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