Cash Flows vs. Account Balances

April 28th, 2006

All That Heaven Allows full movie Beavis and Butt-Head Do America film What’s more important – having a large bank account balance or a healthy positive cash flow each month? I’m sure both are important, but which one should we focus our attention on when budgeting? Should we budget and plan based on money in our bank accounts? If I want a new plasma TV that costs $2,000 and I have $8,300 in my bank account, I could make that purchase stress-free right?

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Remember the Titans movie Stick It hd The amount in a bank account is the least important factor when making expenditure decisions. To increase our wealth and achieve independence, the primary factor we need to control, manage and think about is our cash flow. If I’m spending $100 more than I make each month, buying a $2,000 TV is a bad idea, even with $8,300 in the bank. In a negative cash flow situation, that balance will quickly diminish and with it the false sense of security it created.

Too often, we buy something or make a big financial decision based on the amount of money we currently possess and then find ourselves frustrated later on when we realize we aren’t progressing financially. In the words of Robert Kiyosaki

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, we’re stuck in the rat race! If we aren’t carefully tracking our monthly in-goes and out-goes we don’t have enough information to make sound financial decisions. The only way to increase our wealth and get out of the race is to manage our cash flows, i.e., spend less than we make and intelligently invest the positive cash flow.

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Entry Filed under: Saving

9 Comments

  • 1. Miserly Bastard  |  April 28th, 2006 at 10:12 am

    Wow, I couldn’t disagree more! You’ve essentially framed the difference between income and wealth. Income is cash flow, whereas wealth is capital. Making financial decisions based on your income is the WORST long-run decision in my mind. Your financial decisions should be made based on your wealth.

    NYC is filled with people making $100k a year, and theoretically “living below their means”, but their wealth is minimal. So they work and spend, work and spend, and save whatever is left over. The problem with this approach is that they aren’t maximizing their wealth creation, because they feel they can “afford” their purchases based on their cash flow.

    Income is based on a depreciating asset–you. You have a limited working life. Eventually, as you approach mid-career, you’ll start worrying about layoffs, etc. At some point, you’re going to want to retire and stop working. This is where wealth comes in. If you have the wealth, you can retire. If you do not, you end up having to continue to work for income.

    So I’d posit that the right way to make financial decisions is based on your wealth. If you have a good net worth that has made good progress against your retirement goals, then go ahead and buy that plasma TV. But if even if you have great income (e.g., $100k+ per year), unless you have used that income to build real wealth, you should defer the decision.

  • 2. Jared  |  April 28th, 2006 at 11:10 am

    Thanks for your comment! I really agree with what you’ve said, but maybe I should have been a bit more detailed because I think you’ve misunderstood the post. I added a few words to the post to clarify the principle I intended to convey.

    Ultimately, wealth is all that matters (in the world of finance) and accumulating it should always be the goal. I also agree that a large income means nothing if it’s not managed correctly. I did not say an income is more important than wealth – I don’t agree with that in the slightest. I believe in the long run a school teacher has a better chance of being financially free than a lawyer does if the school teacher manages his/her cash flows in a way that allows for wealth accumulation.

    I explained that, when making big decisions, considering your cash flow situation is more important than the amount you possess. If I have $1,000,000 and make $50,000 a year on interest, should I carelessly buy a $500,000 yacht because that seems minimal compared to the million?  Or, should I refrain, because in reality I should be basing the decision on the $50,000? If I focus on the cash flow, I retain my wealth (the million dollar principal) and preserve my financial independence.

    Also I think the example of someone in New York making $100K is a contradiction. If they were in reality (not theoretically) living within their means (meaning they’re spending much less than they make so they can invest the rest), they’d have the ability to save, invest and create more wealth. How do you propose we accumulate wealth if we don’t carefully manage the money we earn and then utilize it in wealth-creative ways?

    Thanks again for your comment. I think we agree with each other. I just should have been more specific in the first place.

  • 3. Jared  |  April 28th, 2006 at 7:48 pm

    Another thought regarding cash flows… Miserly Bastard erroneously equated income to cash flow. One of the points of the post was to expose that misconception. When I mentioned cash flow I was referring to net cash flow (as the post denotes); in-goes minus out-goes. That remaining balance is the money you should be working with when deciding on big expenditures, not your total income. Income is just one component of your cash flows. If you make $200K a year, but spend $190K on expenses you definitely aren’t a prodigious accumulator of wealth and will most likely remain in the rat race. Miserly Bastard said, people “aren’t maximizing their wealth creation, because they feel they can ‘afford’ their purchases based on their cash flow.” I disagree. If they were aware of their dire cash flow situation they wouldn’t think they could afford their extra purchases. To state it correctly – people aren’t maximizing their wealth creation, because they feel they can afford their purchases based on their income, and are unaware of their cash flow situation.

  • 4. » Carnival of Perso&hellip  |  April 30th, 2006 at 8:54 pm

    […] If you want to evaluate your financial situation, you have to look at both your cash flow and your account balances. The FireValt Blog presents an explanation for why both financial statements are important and which one may be more important than the other. (251 words.) […]

  • 5. Kay Bell  |  May 2nd, 2006 at 3:41 pm

    Enjoyed your posting. I mentioned it in my notification that the Festival of Frugality #21 is up: http://dontmesswithtaxes.typepad.com/dont_mess_with_taxes/2006/05/frugal_.html

  • 6. Andrew - Money Supply & Debt Blog  |  May 9th, 2006 at 5:05 pm

    I think the problem with your post was that you framed it by bank account balance. The reality is that should, in theory, be a small percentage of your overall wealth.

    In order to make the most responsible decision you have to look at both cash flow and wealth. My answer — If you have to reason with yourself that you “can afford it” then you probably can’t.

  • 7. Russell Page  |  May 24th, 2006 at 1:49 pm

    “Income is based on a depreciating asset–you.”

    I couldn’t agree more. I see people making posts and writing all day long about how people are the assets that make the businesses grow in this world, yet they don’t stop to realize that they really are the asset.

    networth, cash flow, etc.. don’t mean a thing without you.

    Not much really exists without people. Web, real estate ownership, laws, etc… Cash flows don’t exist without people either.

  • 8. » Wisdom of Rich Da&hellip  |  February 1st, 2007 at 3:33 am

    […] The FireValt Blog (http://www.firevalt.com/blog/2006/04/28/cash-flows-vs-account-balances/) tried to compare the important of Cash Flow with Account Balance, and concluded that Cash Flow has more importance in building wealth. What’s more important – having a large bank account balance or a healthy positive cash flow each month? I’m sure both are important, but which one should we focus our attention on when budgeting? Should we budget and plan based on money in our bank accounts? […]

  • 9. Affiliate Reviews Trainin&hellip  |  August 31st, 2008 at 8:19 am

    Affiliate Reviews Training And Tips…

    You are right I think you have said it very well…


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