Sunday, 28 October 2018

Cash is not King. Cashflow is.

When it comes to the topic of investing, I believe everyone out here wanted the same outcome - which is to allow our money to grow. In another words, by investing, we want our money to come out more than what we place into.

But sadly, the perfect world is never constructed in such a fashion and it is not always the case as there is many that actually came out with lesser money than injected.
Being a not-very-smart investor myself, I believe that aside the homework or due-diligence that is done, we need a fair share of luck to help us out as well.

By receiving dividends from my stock holding, it does provide me with a decent level of comfort, and at the same time, it does help me a little by reducing on my transaction fees as there is lesser buying and selling.

When a company pays us dividend, this actually creates an additional source of income for ourselves, which increases our cash flow. 

Similarly to a business, cash flow is a very important aspect in our financial state.

When we spend more than what we earn, our cash flow is negative. To finance the expenditure, we will have to tap on our retained earnings (savings) or take up loan to do so. However, if a negative cash flow is a norm, our savings will deplete or we will end up with a snowball of debt.

If we do not know how to manage our finances, regardless of how high our salary is, we will still end every month with a sad note, while we anxiously wait for our salary to be in.

If you're taking home $3,000 a month and spending $2,500 each month. We're still positive with $500 here. This will also translate to a spending rate of 83%

However, if you're spending $4,000. This is when you have a negative cash flow of $1,000!

Assuming, the salary now increases to $5,000. Taking the same rate of spending, we're actually looking at positive cash flow of $1,500!

The equation today is pretty clear cut.

To increase our cash flow, we can either:
1. Increase our income/Create additional stream of income
2. Decrease our expenses

Optimally, both 1 and 2 has to be done together to yield the best result. 

So why is cash flow exactly the King and not cash?

I'll draw a simple example to illustrate this.

Person A, retired with $200,000 in cash. Spending $1,000 every mth, with inflation at 3%. This person will not be able to make through the 14th year. Person A has a negative cash flow every month and has been using his savings to make it through.

Person B, retired with $200,000 in assets generating 5% dividends per year, inflation at 3%. This person will not be able to make through the 26th year. And yes, person B is having a negative cash flow as well! But with a source of income, the impact he'll face to die from hunger is delayed by 12 years!

Realize the differences?

So what if one has an inflow greater than outflow

Your guess is as good as mine. With a greater inflow than outflow, this person will be able to even accumulate more wealth as he is spending money! 

If this person continues to re-invest his excess cash into this retirement pot, he would probably be able to survive till the day Hades decided to look for him!

But again, at certain point of times, being filled with cash represents opportunity. But if the cash here is not being used meaningfully, it defeats the purpose and the cash here is just a stagnant pile of papers. 

By having a certain level of cash with us, this will provide us with some form of hedging. But if we are overly-hedged we have indirectly incurred more losses to our monies than we could do to "protect" it!

To make it clear, it is important for one to have cash to protect themselves. When they're lucky with cash, they will be presented more opportunities. 

However, if we do not make good use of it, it is still useless.

Whereas, it is essential for us to have a strong free cash flow.

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  1. Wow, this is a good read, this was informative as usual and this is what I believe in as well, I am trying to achieve a good cash flow as well, hopefully in the near future.

    1. Hi Edwin,

      Thanks for the kind words :) I believe you're doing well and certainly will meet the targets you've set for yourself soon! :)