Financial independence is all about cash flow. It is the point where your additional income (such as income from your investments rather than salary or wages) meets or exceeds your cost of living.
So how do you get there? To achieve genuine financial independence, and all the normal living benefits that go with it, you need to make sure you handle your cash so that it grows. You need to create positive cash flow by investing in cash-creating assets. That way you can create an additional source of income, over and above the income you earn by working, to help you reach financial independence sooner.
No matter how much money we have, or what stage of life we are at, we all have to make decisions about cash each and every day. Some of these are small, some are much bigger. All of these decisions, big and small, highlight the importance of managing your cash flow.
How to handle your cash
Whether you are living comfortably or not or whatever your age maybe. It doesn’t matter whether you are a successful investor or starting out your first job, or whether your cash comes from salary, business income, share dividends, rent or even by other means.
What matters is how much of your cash you actually keep and how you handle it.
While we all manage our cash flow differently, we often fall into one of three cash flow patterns.
Living for now
Living for now cash flow pattern is simple. Money comes in as salary and goes out to pay expenses. None of the income is saved or used to buy investment assets.
The lack of savings is the obvious problem. There is no money being put away for a rainy day, no wealth being accumulated and no money set aside to prepare for retirement. People caught in this cash flow pattern rarely have long-term debt, such as a home loan. This may be because they are unable to afford it or they may be considered a poor credit risk.
Surprisingly, some highly-paid individuals have a living for now cash flow pattern. They earn high incomes but spend everything they earn.
Most may live an expensive lifestyle, but only if nothing goes wrong, if they keep their job and stay healthy. Unfortunately, they almost have no change at the end of each year and, as a result, they could potentially suffer a lower standard of living in retirement.
The key line is the flow of money from assets coming back into your income – that is the income generated from investments that create more cash.
By investing in assets such as term deposits, shares, investment property, or managed funds, you are creating cash. You can use this extra cash to meet expenses and, more importantly, invest in more cash-creating assets.
While many people are living for now or focusing on looking rich, to achieve genuine financial success – and all the lifestyle benefits that go with it – you need to handle your cash so that it grows. You need to create positive cash flow by investing in cash-creating assets.
By doing this you can create an additional source of income over and above the income you earn. That is what wealth creation is all about.
Set goals for yourself
The first step to better cash flow is to visualise where you want to be financially. The best way to do that is to write down your money goals. Your goals might include:
- saving for your dream holiday
- creating wealth by expanding your investment portfolio
- saving for your children’s education
- saving for your own home
- building a larger retirement nest egg so you can retire sooner
Make sure you don’t limit your goals to what you think is achievable now. If you are really serious about changing the way you manage money, write down what you would like to achieve or have in five years or so.
When setting your goals there are a number of factors you should consider:
- Your health
- Upcoming financial commitments
- short term obligations
- existing debts and assets
- likely income
Once you have committed to a list of goals, you will have a stronger motivation to change your money habits. Make sure your goals are specific and put a timeline next to each of them so that you can monitor your progress. For example, double my investment portfolio in the next two years.
It is also important to review your goals regularly as your situation and priorities may change, for example, you may switch careers or start a family.
Pay yourself first
One of the most difficult but also more important aspects of cash flow management is having the discipline to pay yourself a set amount to cover your day-to-day living expenses. By using a one central account you can arrange to have your living expenses and bills being paid when required and the remainder of your salary can be moved to a second account to able you to save, so the money you have worked hard for starts working hard for you.
Think like you are a business owner
You don’t have to run your own business to be successful, but it helps if you think like a business owner.
All businesses use two common measures to monitor their cash flow – an income statement and a balance sheet.
In a personal situation you will ideally have your incomings and outgoings. This tracks what you earn against what your expenses are.
Businesses use these measures to help them make financial decisions – investment, borrowing, cost-cutting and expenditure. You should try to do the same. Like any business you should understand your own incomings and outgoings and review them often to track your progress.
Good businesses look to minimise their cost-to-income ratio. If you can calculate your own cost-to-income ratio, or the proportion of your income that goes to meeting your expenses, you will be better placed to save money, reduce debt and start to build positive cash flow.
Thinking like a business and tracking your own cash flow measures can help you to better understand your existing financial position and how you manage your money.
Start budgeting
The first step towards controlling your cost-to-income ratio is to have a budget or cash flow plan. Your budget should take into account your entire financial position so it is important to make a list of all of your expenses. Speak to your financial adviser or accountant for some useful tools to get you started.
Get advice
One of the key roles of a financial adviser is to help you practice better cash flow management.
Smart Advice team has the expertise to give you personalised advice on ways to manage your cash more effectively.