Cash Flow Statement

After the personal balance sheet, the cash flow statement is the second tool we’ll be using to answer question one:where am I starting?” and establish our baseline. It will also be a useful tool when it comes to identifying areas for attention when we get to developing our action plan, and is also something we will revisit occasionally when we ask ourselves how am I doing?”.

What is a cash flow statement?

It’s nothing more than a list of where your money comes from (income) and goes (expenditures) within a defined period — monthly would be appropriate.

NB: I’ll probably interchange between using “expenditures” and “expenses” — we aren’t accountants here, and for our purposes, they mean the same thing.

Really. That’s it. Just like our personal balance sheet, we don’t have to answer to anyone else here, so as long as you stick to your own rules, you can’t go wrong. Where does your money come from each month, and where does it go? That’s all you’re documenting on the cash flow statement.

Net cash flow = incomeexpenditures

Let’s look at a simple example:

Salary (after deductions and witholding) $2,090
Interest (CDs, etc.) $10
Total Income $3,000
Rent $1,500
Minimum credit card payments $200
Groceries $500
Home bills (gas, electricity, cable TV, internet) $300
Cell phone bill $100
Dining & entertainment (beer & pizza) $200
Total Expenses $2,800
Net cash flow $200

What does a cash flow statement tell us?

You can draw a few simple conclusions from your cash flow statement:

  • If your net cash flow is a positive number, you are operating at a surplus. You are richer (or less poor!) at the end of the month than you were at the beginning — your net worth is increasing. Even if your net worth is negative, at least you’re moving in the right direction.
  • If your net cash flow is a negative number, you are operating at a deficit. This means you’re spending more than you’re earning, which isn’t a good thing. Don’t panic — one of our first goals should be getting this number above zero.

What should I include on a cash flow statement?

Three principles you should stick to are being comprehensive, consistent and conservative in what you include in your personal cash flow statement.

Being comprehensive means including all of the items you can reasonable expect to receive (income) and pay (expenses). Items you include in your income should include salary, guaranteed interest income (from CDs, etc.), alimony, etc. Items you include in your expenditures should include all bills, rent / mortgage payments, groceries, entertainment, minimum debt repayment obligations, and anything else you see leaving your bank account or wallet. Don’t forget to include cash you withdraw to pay for out-of-pocket items.

Consistency is all about including or excluding the same items each time you look at your cash flow. You’re kidding no-one but yourself if you change the scope of your cash flow analysis to make your financial situation look healthier.

Perhaps the most important of the three principles is conservatism. This is all about making sure your cash flow errs on the side of underestimating income and overestimating expenses. I don’t mean wild over- or under-estimates, but if there are any figures you aren’t 100% certain about, guess low for income, and guess high for expenses.

You could include an estimate of your annual bonus, apportioned (divided) by twelve in your monthly income, but I wouldn’t recommend including it at all — it isn’t guaranteed income, and a bonus should be just that — an extra cash lump sum. If you aren’t budgeting on receiving this, you can choose what to spend it on when it arrives. However, you should apportion and include your anticipated annual expenses — such as car and home contents insurance premiums, apportioned into your monthly expenses (i.e. divided into imagined monthly installments). If you’re trying to apportion your next car insurance premium and aren’t sure exactly how much your next bill will be, look at your last one and add 10%. Budget for that in your cash flow statement.

If your cash flow statement misses out on documenting some potential income you might receive, the worst that happens is you have a nice windfall, a little extra spending money, or perhaps don’t repay a debt quite as fast as you could have.

If you forget to document a major expense you should have anticipated, you can find yourself with much more serious problems, especially if you have insufficient current assets to pay those bills.

Including savings

If you’re already making regular payments into savings accounts (401ks, IRAs, instant access savings accounts, etc.), you can choose whether to deduct them from your cash flow statement or not. If you choose not to deduct savings (and if these payments aren’t being paid through your employer, and thus already reflected in your salary figure), you need to remember when looking at your net cash flow figure that you’re already investing part (or all) of this figure each month.

If you choose to deduct savings, your cash flow statement could look like this:

Income $3,000
Expenses $2,800
Net cash flow
Savings $150
Net cash flow after savings $50 

Your net cash flow after deducting payments into savings accounts, if positive, is money you have “left-over” each month. You might decide to use this extra $50 to make extra payments to a credit card, or increase your 401k contributions. We’ll discuss how you prioritize these decisions when we answer question 2: “where am I heading?”.

There’s a good article on understanding personal cash flow at Personal Finance Digest.

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One Response to Cash Flow Statement

  1. Pingback: Question 1: Where am I starting? | Answer Four Questions

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