Summary
- Cashflow is the movement of money into and out of your financial picture over time
- Examining your cashflow is often the first step we take with clients on their financial planning journey
- Types of cash: operating cash, emergency fund, planned spending
- What to do with your surplus cashflow isn’t a question with a one size fits all answer, but we do have guidance about how to think about it.
- Cashflow connects to other key topics of financial planning
What is Cashflow
At the most basic level, cashflow is the movement of money into and out of your financial picture over time. Usually examined at a monthly or annual frequency, cashflow tracks money coming into your financial life compared to money going out.
Incoming money can be salary or wages, business income, investment returns, rental income, profit from the sale of property, and more. Outgoing money can be bill payments, every day purchases like groceries, debt payments, healthcare costs, taxes, and much more.
When looking at a specific period of time, such as a month or year, it’s common to subtract your outgoing money from your incoming money, resulting in your net cashflow. Net cashflow can be positive, meaning you’re bringing in more money than you’re spending. Or negative, you’re spending more than you earn. Of course, your cashflow can be near neutral if your incoming cash matches your expenses almost exactly.
Why Cashflow Matters
Examining your cashflow is often the first step we take with clients on their financial planning journey.
Zooming in on monthly net cashflow may help you identify spending patterns that are unsustainable or reveal opportunities for debt repayment or investing. Comparing these smaller windows side by side over time allows you to identify daily, weekly, and monthly habits you’ve already built or can improve upon.
Zooming out on longer periods of time allows you some ability to project where you could be in a year, two years, ten years, or longer. Is your annual net cashflow increasing or decreasing year-over-year? Did a home remodel, vacation, or child going to college make a specific time period more expensive than others? Is your income growing competitively with inflation?
But it goes further, because cash plays several important roles in a financial plan.
Thinking About Cash
We can think of cash in a few different ways:
- Operating cash: This is money for regular spending, used to pay your mortgage, buy groceries, cover insurance and utilities, etc. Most people keep this money highly accessible in a checking account.
- Emergency fund: A lump sum of savings set aside for the unexpected, like job loss, car repairs, medical bills, or home maintenance. Most people keep this money in an accessible savings account. It’s common to have 3 months to a year of expenses saved, but guidance about how much cash to maintain in an emergency is very case by case!
- Planned Spending: Some expenses aren’t routine but are predictable, like buying a new car, getting married, going on vacation, replacing your roof, etc. Often, people try to anticipate how much these larger expenses will cost and when they may occur, and set aside cash monthly to save that amount of money in time.
If your operating cashflow is positive, that gives you the ability to contribute to your emergency fund and your planned spending. And if your planned spending and your emergency fund are robust enough, they can prevent your operating cashflow from dipping into the negative for any major expenses, expected or unexpected.
“Too Much Cash”
You may have heard financial professionals say something along the lines of ‘you have too much cash’ along your financial planning journey. If your operating cashflow is positive, even considering contributions to your emergency fund and planned spending, we do want to examine the surplus for opportunities. We want to make sure that your cash is working for you, where and when you need it!
What to do with your surplus cashflow isn’t a question with a one size fits all answer, but we do have guidance about how to think about it.
- Match the saving/investment vehicle to your goals: Every dollar doesn’t need to chase the highest yield. Cash you need to access in 1-2 years belongs in a different account from money you intend to save for 30 years.
- Life happens along the way: Saving for retirement is great, but we want you to enjoy the climb. Career flexibility and family memories over the years are a legitimate use of surplus cash.
- A realistic saving plan beats an optimized one: The best plan is the one you can stick to, and that doesn’t cause you additional stress or anxiety.
- Avoid ‘Fear Cash’: Keeping your cash out of investments due to fear of the markets is understandable, but trying to wait for the perfect time to start investing can cause indecision and inaction.
How Cashflow Fits Into a Financial Plan
Before we can help you plan investments, insurance, or retirement, we need to know what’s available to work with. We can’t set realistic savings rates, debt payoff timelines, or investment contributions without knowing your cashflow surplus or deficit. Here’s how cashflow connects to other key topics of financial planning:
- Investing: When you are saving for retirement, your surplus cashflow is what you have available to invest.
- Taxes: Tax strategies directly influence how much cash you pay toward taxes, and how much cash you keep. Taxes are an ‘outflow’ in the cashflow equation, and your net cashflow is influenced by the amount of taxes you pay.
- Risk Management: You can think of different types of insurance, like life insurance, disability insurance, health insurance, etc., as cashflow insurance. You’re paying a small predictable amount now to make sure you don’t experience a catastrophic unpredictable amount in the future.
- Retirement Planning: The question of ‘am I ready to retire?’ is fundamentally about cashflow. If you have enough saved to cover your cashflow needs for as long as you need to, you’re likely ready to retire.
- Estate Planning: As it relates to estate planning, cashflow is about making sure that when you’re gone, your surviving dependents can still access the cashflow they need to cover expenses.
One example of how cashflow planning provides a foundation to financial planning is about debt payoff and increasing net cashflow. Let’s say you save a little each month, you have a slight positive cashflow, but the margin is thin enough that one unexpected expense could tip your cashflow negative. Let’s add that you also pay a significant amount of consumer debt payments each month. If you aggressively payoff that debt, either via lump sum or over time, you can dramatically increase your positive cashflow. This allows you to build up an emergency fund and stash funds for planned large expenses, which prevents future consumer debt. You might even be able to start investing some your surplus. The point is: if we didn’t analyze the cashflow, we may have assumed that the slight positive cashflow was all we had to work with, when really we were able to make a bigger plan.