Today I would like to take the time to examine another fundamental of wealth building: cash flow.
What is cash flow? Few concepts are more important to fully understand than this one. It doesn't matter what great idea you might have to build your wealth. If you don’t understand the basic principles behind cash flow you're doomed for failure.
You find a way to pull in a six figure income over the course of the year and still find yourself scrapping along broke. Income, taken by itself, isn't cash flow! A high income with improper cash flow management is perhaps the most dangerous way to live and is a surefire ticket to bankruptcy.
Don’t understand? Well, that’s why I’m here to explain it to you.
It is a little known fact that most winners of the lottery end up worse off than when they started. Having several million dollars in the bank does not make you rich. When people win the lottery, the first thing they usually go out and do is spend their lucky win on LIABILITIES.
A liability, in accounting terms, is anything that ends up sucking money from your bank account without an offsetting cash return. A good example of this is a fancy car. A fancy car is nice to own and might even raise your personal happiness level, but it's ultimately a liability. You have to pay high insurance premiums to keep it covered and maintenance can cost you a bundle. The car will lose value over time due to depreciation (wear and tear accumulated over time). Now, if you've got a proper cash flow for this type of luxury, all is fine, but if your money is simply sitting in a bank you will be amazed at how quickly even a car will gobble up the funds in your account. The same holds true for a nice house, a nice TV, and all the other little luxuries you might find yourself drawn to once you have some money.
People who win the lottery usually end up trying to live the lifestyle they equate with such a strong bank account and are usually shocked to find that, as little as a year later, they have nothing left. In the end, their money itself was a liability, as it only led to negative cash flow!
That's a rule to take to heart. Money in the hands of a person with no understanding of finance is ultimately a liability. Such a person can have all the money in the world and will still end up broke.
Taking this concept to heart, we can proceed to define what wealth really is. Wealth is not the possession of a certain value in property, but rather the amount of positive cash flow over a certain period of time. A person who brings in $200,000 a year and spends $195,000 in expenses is far worse off than a person who brings in $60,000 but limits their overall expenses to $20,000.
Cash flow, then, is the amount of income one draws from one’s assets minus the expenses that person pays due to their liabilities. That’s really all there is to it. The trick, then, is to find a way to maximize asset income while minimizing liability expenses. Most people screw this up, which is why they don’t go anywhere over the course of 20 years.
An expensive home is a liability. Yes, some will mistakenly label it as an asset - after all, isn’t a home ultimately an investment? After you've gained enough equity (ownership) of the home, can’t you sell it or mortgage it for money later on? Sure. Such an approach, however, misses the mark on numerous points which I’ll cover in a later posting. The key to remember is that an expensive home is going to take far more money out of your wallet over the course of the next year than it will ever hope to bring in. For our purposes, that makes owning an expensive home a major liability for the goal of wealth building. The money you're spending on your house, if allowed to grow as positive cash flow, could be used to acquire actual assets that will increase your cash flow. Having done this, housing costs won’t take a major bite out of what you bring in every year down the line.
There are only two ways to increase your cash flow - you can increase your income through investments in assets or you can decrease your expenses by getting rid of your liabilities. There is no way around this. You cannot become wealthy unless you are constantly doing either (or preferably, both) of these things.
Now, I’m not saying that you have to avoid liabilities - far from it! There is next to no point to becoming wealthy if you aren’t allowed to live a life that reflects it! The often overlooked key, however, is that you must take every effort to ensure that the expenses from your liabilities do not measurably cut into the wealth produced by your cash flow. A person who's found a way to create a $10,000,000 positive cash flow every year can afford to live in a multi-million dollar home. A person whose bottom line cash flow shows several thousand dollars probably should reconsider, even if it's within their means.
Your assignment today, then, taking into consideration all the great stuff you dreamed in from the last posting, is to examine where you are in your life today. What contributes income to you at the end of the year? What cuts into your cash flow that you can do without? Don’t think in overall money value - think in terms of what makes you money and what takes money out of your pocket.
It's absolutely essential that you train yourself to think in these terms if you're ever going to build the fortune that's rightfully yours.
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