I always hear about how cash flow is king so I decided to dedicate this post to analyze whether cash flow is indeed “king”.
What is Cash Flow?
When defining the fiscal strength of an individual, the most important financial aspect to consider is the cash flow. Cash flow is the movement of money within any given account, of course, a positive cash flow is king. Factors consistently replenish and deplete funds within that account, these include expenses like rent, debt payments etc. and positive factors, like income, rental income, dividend income etc. This movement of funds is typically observed for a set period of time and then this is used to determine whether one has positive cash flow or not. This figure is then represented in a statement of cash flow and can be used to determine the specific factors of an account that are performing well and those that require improvement or adjusting. It sort of works like a budget, but not really.
Types of Cash Flow
There are three primary types of cash flow that are analyzed for the cash flow statement. Each will apply to both businesses and individuals in different ways. The first is operational cash flow. Operational cash flow, as the name implies, results from the money generated by typical operations. This means the production of a good or service for a company or the income generated from a job or side hustlin’ projects for individuals.
The money spent and received on investments is the second type of cash flow. There are many different types of cash flow investments. RRSP’s, stocks and bonds are common sources of investment cash flow for individuals. My utmost favourite is the DIVIDEND. Dividend income is favourably taxed in Canada, so this cash flow means that the tax man won’t get it. Usually, investments will only result in a positive cash flow after an a long time investing money into the dividends…. a loooong time. For example, if you have $1000 invested in dividend stocks and you get 5% return annually, that’s $50 a year. If you continue increasing your investment and shares in that dividend stock, you will continue to accrue dividend income (as long as the company keeps paying it to you of course). My dream (and no doubt many others share this dream as well) is to be able to live off dividend income (or other sorts of passive income) one day. One day!
Financing for individuals means borrowing money from a bank or business in exchange for repaying the original amount along with any added interest. Negative cash flow occurs here and yes, it sucks.
Obviously a positive cash flow is the ideal outcome. This means that incoming funds exceed outgoing costs. Rental income is an example of a positive cash flow. Positive cash flow with rental income will only result after all expenses have been covered. Consistent passive positive cash flow is a sign of financial success and stability (to me anyway) because it is not dependent on you working to generate this (e.g. you could be sipping a pina colada somewhere in Jamaica and still generate income).
A negative cash flow, as the name suggests, is when the expenses of an account exceed its income. This isn’t so good but is really quite common.
How does Someone Generate a Positive Cash Flow?
It takes time and effort to generate a positive cash flow, but the payoff is pretty sweet. Rental income is a common method for achieving a positive cash flow (hopefully this will be generated for me soon!). Dividend income is a great one but it takes time and discipline to NOT sell your dividend stocks for its capital gain (or I suppose in the recent case, loss). Adsense is another good one (if you have a blog, but you do have to write the content in the first place!) There are many different ways to do this and it takes a bit of creativity but is well worth the effort. However, sometimes you want to make sure your cash flow isn’t so high that you’re taxed to the nines come tax time. There are many ways to reduce your income and taxes, especially if you have rental income or other small business income. In addition, I think it’s super important to make sure you have different SOURCES of cash flow. So that if one screws up, you still have the other to rely on.
So I think I answered my own rhetorical question. Cash flow is indeed king!
Readers, any other sources of cash flow? Which one is the cash flow source you are most intrigued with (e.g. rental income, dividend income etc.?)