Establishing sound personal finance practices while you are young is essential, and thinking about cash flow and net worth is a part of that. For those who are new to personal financial management, you need to think of the long run. Discipline and having the right mindset will help you stay out of debt and achieve your financial goals.
Cash Flow
Cash flow depends not only on your income but also on changes in your savings and debts. If, at the end of the year, you have not saved, and your credit card balance has grown, there is only one explanation – you consumed more than you earned. If you were able to save money or your debts have declined, you consumed less than you earned.
Net Savings
In terms of your take-home pay, you either spend it, consume it, or save it. The difference between income and spending or consumption is your net savings. Your net savings depends not only on how much of your take-home pay you spend during the year but also on whether you increase or decrease the amount of debt you have outstanding in a given year.
- If you increase debt or dip into savings, then your net savings and net worth decline.
- If you reduce debt or add to savings, then your net savings and net worth increase.
It is especially important to analyze cash flow before any significant life transitions. These include buying a home, getting married, changing careers, or starting a business. Transitions can have a big impact on your financial life. Taking a close look at your cash flow will help you determine if you are prepared. Doing this analysis in advance of a significant change will give you peace of mind. Whenever you face a life transition, it is a good idea to have extra money put aside for unexpected expenses and other unknowns.
Getting in the habit of thinking about cash flow will help reduce the likelihood that you will accumulate debts that negatively affect your financial well-being. It will also increase the likelihood that you will save and invest more for the future.
To learn more about how to get started managing your financial life, see our collection of Get Organized posts.
