Cash Flow: What It Is and How It Impacts Every Aspect of Your Financial Life

Cash Flow according to Harvard Business School is the net balance of cash moving into and out of a business at a specific point of time. For instance, when someone who runs a minimart or restaurant orders or purchases inventory the money is flowing out of the business and to the suppliers. And when someone buys something from the minimart or restaurant then money flows into the business. Another example is when a business pays its workers or utility bills. Cash is flowing out of the business whereas collecting a monthly installment on purchase shows cash is flowing into the business.

Cash flow can be negative or positive. Positive cash flow occurs when a business has more money moving into than out whereas negative cash flow is when there is more money moving out of business than in it.

You don’t have to own a business to recognise the important role cash flow plays in business. Cash flow management doesn’t only apply to people trying to run a business it is just as important in our personal lives. Personal cash flow according to nerdwallet.com is your income minus expenses over some time. It helps indicate in what direction your finances are heading.

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How To Determine Cash Flow

One can determine their cash flow by creating a budget. To begin with, write down your monthly income, including any source of passive income then subtract all your expenses. Instead of focusing on a single month consider tracking your expenses for about three months. This may paint a more accurate picture of where your money is going (is it leaning towards negative or positive cash flow?) and how it is contributing to your net worth.

Why Should You Care About Your Cash Flow

• When your cash flow is positive (when your expenses don’t exceed your income) and you are not living paycheque after paycheque this allows you to consider building an emergency fund. When you have more money coming in, this allows you to establish a financial safety net for difficult situations like job loss or unexpected medical expenses.

•  Understanding and managing your cash flow is important in helping you achieve your financial goals. Whether your goal is to buy a home, start a business or go on a vacation understanding your cash flow enables you to set realistic goals and develop a plan to achieve them.

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What Causes a Negative Personal Cash Flow?

• High expenses

One of the major causes of negative cash flow is when expenses outweigh income this may result in a shortfall. These high expenses may result from costs such as rent, utilities or inventory expenses, extravagant purchases, impulse buying, or poor money management.

• Low Income

Not receiving a steady and regular income can also contribute to negative cash flow. Some of the factors that may have led to lower income include economic downturns, market competition, and declining demand from customers. When one is not certain if they will have enough money in their bank at the end of the month, this makes setting financial goals and saving very difficult and may lead to one resorting to taking out loans to make ends meet.

• Excessive Debt Payment

Another factor that could contribute to negative cash flow is having excessive debt burdens, including loan repayments or interest payments. If your debt obligations are high and not managed properly it may strain and drain your income and possibly savings and result in a negative cash flow crisis.

• Inadequate Financial Planning/Budgeting

Having a budget and a financial plan are both important aspects that help you manage your finances. If you don’t have a realistic financial plan and budget in place this might result in inadequate forecasting which could result in underestimating costs or failing to set aside enough money for emergencies and could contribute to a negative cash flow.

• Economic Factors and External Events

Cash flow can be negatively impacted by market disruptions, policy changes, economic recessions, and unforeseen events like natural disasters. These occurrences might lead to a negative cash flow if they lower sales, increase expenses, or create financial uncertainty. 

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How Does Negative Cash Flow Impact Your Life?

• Debt

As a way of dealing with the cash flow gap, one might resort to borrowing money or taking on additional debt. This may result in increased interest payments and even more debt burdens which can further strain your cash flow and financial stability.

• Inability to meet financial obligations

Because you have little to no money flowing into your accounts, meeting obligations like rent or loan repayments may be difficult. This might result in late payments, a damaged credit rating, and even strained relationships with your creditors and landlord.

• Worry and Stress

Not meeting financial obligations, excessive debt,  risk of going bankrupt, and not meeting any of your financial goals are all impacts of having a negative personal cash flow. These factors not only affect your financial well-being but might also take a toll on your mental health and might even lead to anxiety and depression due to the uncertainty surrounding your financial situation.

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How to Improve Your Cash  Flow

• Create a Budget

One of the first things you should consider doing if you are looking to improve your cash flow is to create a budget. It doesn’t matter at what stage you are in on your financial journey, a budget is an important aspect of ensuring your financial success. A budget will help you track, plan, and allocate your resources. It will also help you make informed financial decisions. 

• Use The 50/30/20 Rule

If you need assistance with getting started with your budgeting then consider the 50/30/20 rule. The 50/30/20 rule is a simple budgeting strategy that could help you get started on budgeting or get you back on track after a setback.

The idea behind the 50/30/20 rule is to allocate 50% of your income to your needs. These needs are necessary expenses like rent, groceries, transportation, healthcare, childcare, and utilities.

The 30% of your income could go to wants. Wants are sometimes referred to as nonessentials however these expenses give you the chance to personalise your budget. Whether it's starting a new self-care routine or going out for a movie, adding some fun to your budget makes you more likely to stick to it. Some of the common wants are 

•  Streaming services
• Vacations
• Electronics
• Eating out
• Hobbies
• Entertainment
• Gym memberships

Depending on your circumstances, the remaining 20% of your income goes to savings or debt reduction. If you have debt you could consider splitting your savings and debt repayments. Repaying loans is a step in the right direction if your goal is to live a financially stable life but it is also important to be sure not to shun your savings in the process. 

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• Cut Down on Your Expenses

Once you have a budget set and know where all of your money is going, it becomes easier to cut down on some of your expenses. Your monthly bills for instance are a perfect place to start. You could cut down or reduce the number of streaming services you are subscribed to or you could get a cheaper internet plan for instance.

What Causes a Positive Cash Flow?

• Budgeting

Having a budget can not be overemphasized. Having a budget and sticking to it helps you to ensure you are spending within your means. A budget helps you control and track your spending. It also helps you make the needed adjustments to your financial goals. A budget can prevent overspending and ensures that there is enough money to cover essential costs thus contributing to a positive cash flow.

• Managing Debt Effectively

By paying your debts on time, you could avoid incurring late fees and penalties thus saving money and maintaining your cash flow.  Being able to effectively manage debt can also improve your credit score over time. Having a higher credit score may qualify you for better loan terms and lower interest rates, this further reduces your debt burden and improves your cash flow.

• Steady Income

Receiving a consistent, stable amount of money at the end of the month can contribute to a positive cash flow. A consistent source of funds can be used to cater to living expenses, debt repayments, and saving goals. Having this stability ensures that you can meet your financial obligations and still have enough cash flow to meet your needs.

Read Also: 10 Common Budgeting Mistakes

How Positive Cash Flow Impacts Your Life

• Financial Stability

A positive cash flow provides a safety net from unexpected expenses or emergencies thus reducing financial stress and the chances of going into debt.

• Debt Reduction

Having a positive cash flow allows you to pay off debts at a much faster rate, you can save money on interest payments and also improve your credit score.

• Ability to Save and Invest 

With the extra money, you have the option of saving or investing towards your future goals, your goal could be to buy or build a home, start a business, or save for retirement.

• Peace of Mind

Finally, a positive cash flow enhances your well-being and gives you peace of mind knowing that you can handle financial ups and downs and that you have control over your finances.

Wrapping Up

Improving your cash flow isn’t something that happens overnight.  It might take weeks, months, or years depending on your circumstances. Think of your long-term goals, do you want to save for retirement or build a home? Whatever the goal, think of a plan that will get you there. It might look like you are climbing a mountain and can’t seem to get to the top but every step you are making towards that goal is getting you closer and closer to the peak.