Dec 2nd, 2007
What comes in, what goes out
Once you have a grasp on your total net worth, congratulate yourself, if not on the total, the accomplishment of doing it. It’s a huge step in the direction of financial independence.
That said, it’s one step. Even though it’s a major one, there’s need for a second step to get further along this journey, and the second step would be determining your cash flow.
This basically means determining what your income is and what your expenses are. This can be calculated using figures for a day or a week or a month or a year; in practical terms, figuring out your monthly cash flow is probably the most useful.
There are some simple steps in determining your cash flow, but several significant barriers to determining it properly. We’ll look at both.
Determining your income ought to be easy, or at least easier than determining your expenses. Your income is simply the money you get from work, investments, Social Security, or any other forms of cash coming in. Simply checking your pay stubs for the last few weeks is likely to give working people a very accurate picture of their income. For a more accurate picture, looking at your previous year’s tax returns or W2s can be a huge help–to calculate monthly income, divide your net income by 12.
Determining your expenses is a bit more difficult. For one thing, while sources of income tend to be limited to a handful–even if you have two jobs and two income generating investment accounts, that’s just four sources of income–expenses tend to be far more varied. Right off the top of my head, there’s your housing payment, your electricity bill, your water bill, your telephone bill, your gasoline bill–all stuff that gets paid regularly.
Some of those expenses are very easy to figure–namely the fixed monthly ones. Quick, what’s your rent payment? Is it the same as last month, and the month before, and next month? If you can say yes, you probably know what it is without a lot of head scratching. Some of these, however, are much more difficult to figure out, because they’re not quite monthly and they’re not the same all the time. Think gasoline–the price of gas fluctuates pretty often. Since my fill ups tend to be close to weekly–sometimes six days apart, sometimes eight days apart, sometimes an actual seven days apart–and vary from about 11 gallons to 13 gallons with gas prices fluctuating all the time, it’s very hard to give an accurate figure for how much I spend on gas a month.
In addition to that, there’s expenses that come up far less frequently than monthly–things like auto insurance, which I have the option of paying monthly, quarterly, or semi-annually. These are a little easier to determine amounts to budget for monthly–a $450 GEICO bill every six months is $90 a month.
Finally, some expenses are just difficult to estimate. Ever wonder how much you spend eating out every month? It may not be all that tough to guess how much it is typically, but what about that once a year you take your buddy out for his birthday? How about that baby shower you went to at the local Olive Garden?
In trying to determine your monthly cash flow, it’s likely inevitable that you’ll have to make some estimates. If you really want to accurately track your expenses, consider a spending diary–write down every cent you spend. For it to be a really accurate diary, it must be kept for a year. I do this personally and have for several years with a composition book. There’s also a certain psychological benefit given to those who keep spending diaries–you have to be able to live with yourself when you write those expenses down, making someone like me think, “Am I really needing that new pair of shoes?”
Once you’ve determined (or estimated as best you can) your monthly income and monthly expenses, it’s time to subtract your expenses from your income and see what your net cash flow comes out to be. If your cash flow is negative, it’s time to really figure out how to get it positive (we’ll cover some of this in coming entries). If your cash flow is zero, then at least you’re breaking even. If your cash flow is positive, that’s great, but there’s always room for improvement.
Knowing your cash flow–not just that you’re in the positive or negative and by how much, but where you’re spending your money and where your money is coming from. Like knowing your net worth, knowing your cash flow will help you to make a plan for the future.
