Poor cash flow management is one of the reasons cited for small business failure. That can easily translate into "Poor cash flow management can lead to personal finance failure" for the average man. Indeed, the concept and principles of good cash management are very relevant to personal finance. Just as business owners must exercise prudence in managing the cash inflows and outflows, so must you when it comes to your personal finances.
Cash flow management on the level of personal finances is really about paying attention to your cash needs. You then need to analyse your income and relate it to current and future expenditure. This must be done with a view to creating and maintaining a positive 'net cash flow' for your personal finances. Your cash flow can be identified by looking at your sources of income or revenue:
a) Salary from work/ income generating activities
b) Income from investment (capital gains and interest)
c) Loans and other forms of credit
Cash flow management offers some principles that can be applied to fiscal management at the level of individuals.
1. Identifying and analyzing what your cash needs are and prioritizing.
2. Properly estimating your current and future cash needs and your ability to meet them.
3. Having a plan for meeting your cash needs without converting key assets to cash.
4. Identifying the best sources to meet your cash needs.
The application of these principles helps to avoid financial cancers like bad debt and regular activities like budgeting. Cash flow management essentially forces us to take stock of what we are doing with our savings and income. Therefore, it is important to financial planning in myriad ways.
Budgeting is predicated on sound management of income that creates a cash inflow. You must also manage your cash outflows to ensure that you do not borrow excessively just to meet necessary (or unnecessary) expenditure. Budgeting also encourages us to save for our cash needs. This process is a key manifestation of cash flow management.
2. Managing financial commitments
There is nothing worse than overextending your finances. The only time persons seem to apply ratios is when financial institutions require them. The fact is that cash flow management principles allow us to recognise when we overextend and take steps to correct it. You will not live above your means or purchase unnecessary items on credit because you understand that unbudgeted, unwarranted cash outflows can damage your financial plan. Too many commitments (including undue emphasis long term savings and excess insurance) can lead to a negative cash inflow.
3. Avoiding bad debt or excessive credit
When you have an expected expense or cash outflow (either current or future), you may need to borrow to finance this. However, there is good debt and bad debt. Cash flow management can help you to be aware of the difference between those. It will also help you to relate you credit needs to your income. Therefore, you will avoid taking bad credit or too much credit. Consumer loans and credit card debt will simply be out of the question.
4. Avoiding illiquidity or low liquidity levels
Illiquidity can ruin financial institutions. The credit crunch precipitated the global recession and brought some institutions that were reliant on short-term funding to their knees. When you are illiquid you will feel 'broke'; even if you are asset rich. What do people who are 'broke' do? They get desperate.
They are forced to liquidate when they don't get the best value for their assets or take loans with exorbitant interest rates for want of options. Cash flow management allows us to manage our liquidity so that we can meet cash outflows- even the unexpected ones without facing a liquidity crisis.
5. Risk management
Liquidity risk in investment refers to the inability to sell an asset when you need to. However, other forms of risks that your personal finances face can be identified with cash flow management. For example, you may realise that likely medical expenses may cripple your finances. Therefore, you purchase health insurance to cover that risk. When the unexpected happens- you and your family are covered.
The risk management aspect of cash flow management will also influence how you select your investment options in light of protecting your 'income from investment'. You should seek to avoid not only liquidity risk, but purchasing power risk and inflation risk- to name a few. You will also be able to allocate your assets in relation to future cash outflows and develop different investment horizons. This assists with portfolio diversification.
Cash flow management is not just a term for business owners. It refers to good practise in managing your finances on a whole. In a world where wealth and money is important, good cash flow management ensures that money remains your servant, not your demanding master. Having and maintaining a positive cash outflow reduces the number of problems that you face now and in the future.
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