Even if you are not self-employed, you should make your own statement of cash flows if you want to drastically improve your financial situation. Fortunately, it’s very easy to do. In fact, it will take you less than 30 minutes a year and the payoff is tremendous.
What is a personal statement of cash flows?
Before I answer that, let me give you some background. In business, a statement of cash flows is actually known as a cash flow statement. This report shows business owners how they generated cash and how they used cash
throughout the year.
Now, you might think that every time a business generates cash it’s a good thing, but that’s not true.
Sure it’s great when the business makes a sale and they receive cash. But in a business setting, if you sell assets, you generate cash too and that might not be so good. That’s because you also decrease your ability to do business in the future if you sell off your assets…right? So in some cases, generating cash is potentially a bad omen for a business.
Conversely, using cash isn’t always negative. If a business invests in machinery it is a use of cash but it might lead to future growth and profits. Yummy. You’ll see how this relates to your personal finances in a minute.
For now, let’s just be clear. Business owners use cash flow statements to determine:
- Is the company liquid? Can it pay its bills?
- How is the company generating cash? Is it doing so by increasing sales or by mortgaging its future?
the company using its cash wisely?
Look over these three points above. You probably notice that it might be useful to apply them to your personal situation:
- Are you able to pay your bills every single month?
- How are you paying your bills? Where is the money coming from?
- Are you spending wisely?
I meet people all the time who are able to pay their bills but are doing so by spending down their savings. Of course this is a recipe for disaster. If this describes you, the sooner you realize you have a problem the better.
How do you create a personal statement of cash flows?
1. Inflows of Cash
Here are all the questions to ask in order to create a list of cash flows into your household:
- How much money did you take home last year?
- How much did you receive in dividends, interest and/or capital gains?
- Did you receive any >distributions from retirement accounts, business interests or gifts?
- Did you make any side income from a second job?
- These are all great sources of cash. Here are some other sources that aren’t quite as comforting:
- Did you take on any personal loans or use a company like Prosper to arrange an unsecured loan.
- Did you tap into any equity in your Home Equity Line of Credit?
- Did your credit card balance rise?
- Did you pull money out when you refinanced the mortgage?
These are all sources of cash too but as you can see; they paint an entirely different financial picture, don’t they?
2. Cash Outflows
Now let’s consider all your uses of cash.
- How much did you spend on your standard of living?
- How much did you
- How much did you save and invest?
- How much did you pay down your debts?
These are all uses of cash and as you can see, many of them contribute to your long-term financial health. Don’t assume that every use of cash is bad.
At the end of the day, the inflows and outflows must equal each other or at least be very close. If you have large discrepancies, look again because you’ve overlooked some important items. You may have forgotten a source or use of cash. Of course the easiest way to keep a cash flow statement is to utilize a budget tracking system like YNAB (You Need a Budget) but it’s not the only alternative.
In my 28 years’ experience I am sorry to say that very few people ever take the time to create a statement of cash flows. Maybe it’s because they really don’t want to know. Of course I am not exactly sure why that is but I think people fail to look at
their finances as if it were a small business. That is a huge opportunity they miss in my opinion.
By creating a personal statement of cash flows you’ll know exactly what is going right in your financial life and what needs attention. How else are you going to know what is going on? How else can you get to where you want to go if you don’t know where you are?
Do you create a personal statement of cash flows? If so, how has it helped? If not, why not?
Visit the California Institute of Finance’s Website to learn more about our MBA In Financial Planning program.
Neal Frankle is a Certified Financial Planner with more than 25 years of experience, author of the Wealth Pilgrim blog, and a featured contributor here on the “Advisor Blog”.