Before any planning, the first task is to ensure that the net cash flow is positive. This surplus can be used to meet various financial needs. However, if the net cash flow is negative, it will just lead to more borrowing and it may be difficult to get out of that situation.
Managing your cash flows can be a tedious task.
Who wants to track all their expenses month after month, only to find out that you haven’t been as smart with your spending as you had originally thought?
But that is exactly why cash flow management should be an essential part of your financial planning. To understand how to manage your cash flows, first, you must understand what a cash flow statement is.
A cash flow statement measures the cash inflows and outflows of a business or a person, to calculate the net cash flow for a specific period.
Cash inflows include income from salaries, dividends, interest from savings accounts, capital gains on the sale of assets or securities, etc.
Cash outflows include house rent, electricity, water, and other utility bills, children's school fees, entertainment expenses on movies, restaurants, vacations, insurance premium payments, etc.
The net cash flow can be calculated as:
Total monthly expenses (-) total monthly income
Positive net cash flow indicates that money earned was greater than the money spent, and conversely, a negative cash flow indicates that the money spent was greater than the money earned for the specified period.
Before any planning, the first task is to ensure that the net cash flow is positive. This surplus can be used to meet various financial needs. However, if the net cash flow is negative, it will just lead to more borrowing and it may be difficult to get out of that situation.
How do we ensure that our net cash flow is positive?
Keeping the cash flow positive is a vital part of wealth generation and investing. In order to build a successful investment portfolio, you should know exactly where the money is coming from and where it’s going. You can start by simply keeping a track of your income and expenses.
Often income does not move on a month to month basis but expenses may fluctuate. Let’s understand why can expenses fluctuate. There are two types of expenses, fixed and variable. Fixed expenses do not fluctuate and are often range bound. House rent, EMIs etc. are fixed. However, variable expenses fluctuate and can have a high volatility month on month. Travel, eat out, shopping etc are variable expenses.
List down all your expenses on a monthly basis. Break it down into the fixed and variable bucket. Once you have a written down everything, it is much easier to make necessary adjustments in your variable expenses.
You have discretion on variable expense but not on fixed expense. A practice to ensure range-bound variable expense will help to generate positive net cash flow (surplus). These surplus funds can be invested to meet your short-term and long-term goals.
Why should we analyze our cash flows?
When we think of the term 'investing', it seems more exciting than the term 'financial planning'. However, both processes are closely interrelated and interdependent. If you do not have a solid financial plan and do not monitor your cash flows, then you would have no idea how to start investing. Moreover, making a plan for the future with regards to investments for things such as retirement, insurance planning, debt management, etc would be almost impossible.
The outcome of Cash flow analysis can be an important input for other planning aspects:
1. Retirement planning
Investing a certain amount of savings today for a specific period to build a retirement corpus is essential for a comfortable post-retirement living. You can take a look at your cash flows to calculate the required monthly savings to be invested and meet your retirement goals successfully.
2. Insurance planning
To determine a sufficient insurance cover, cash flow analysis especially 'income' analysis can give you an idea of your potential of making money for the rest of your working life. Insurance cover should ideally be a discounted value of the working life 'income' plus any loans outstanding.
3. Managing debt and purchasing assets
If you plan to buy a house or a car, it is crucial for you to analyse your cash flow position in order to assess whether you can afford it.
Different financial needs require funds and those funds are created by your cash flow. Ineffective cash flow planning can lead to a financial stretch especially if the surplus is not created and not invested during working life.
Personal cash flow management facilitates better understanding and prioritization of financial goals.
Disclaimers
Investment in securities market are subject to market risks. Read all the related documents carefully before investing.
The securities quoted are for illustration only and are not recommendatory.
Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.
Details of the advisor
Advisor: Ankur Kapur
SEBI RIA No.: INA100001406
BASL Member ID: BASL1337