What Is Cash Flow?

What Is Cash Flow?

Your cash flow indicates how much money is moving into and out of your bank accounts. A positive cash flow means you're bringing in more than you're spending, while negative cash flow means your expenses exceed incoming funds.

Applying the concept of cash flow to your personal finances makes it easier to establish and maintain a household budget that helps you achieve your goals. When you have positive cash flow, you can use that leftover money as disposable income and spend it, but you also have an opportunity to save or invest it for short-term goals, like travel or buying a home, or long-term goals, such as retirement or a baby's future education. Negative cash flow can restrict your options and cause you to accrue large amounts of debt.

Cash flow can provide an insight into your finances that factors in more than simply the income you bring home each paycheck. After all, you could earn $1 million a year and still be cash poor with a negative cash flow if you live a lavish lifestyle that causes your expenses to exceed your income.

By adding up your monthly expenses and subtracting the total from your income, you can determine your cash flow and whether it's positive or negative. Based on what you find, you can use that information to make changes to get back on track.

Why Is Cash Flow Important?

At the end of the day, understanding your cash flow is key to ensuring you're not living beyond your means. When you've paid your expenses and have money left over, that indicates positive cash flow and contributes to financial stability.

Using this leftover money strategically can be an effective way to prevent debt from becoming unmanageable. You could also use your surplus to pay existing debts, such as high-interest credit cards, student loans, car loans or a mortgage, to bring down balances faster and reduce interest payments.

If you use your income to pay your expenses and have nothing left, or don't have enough to cover required expenses, it indicates negative cash flow. This could happen due to circumstances beyond your control, such as rising costs of living, unemployment or surprise expenses.

But some people find themselves with a negative cash flow because they're spending more than they earn. This is a recipe for financial disaster since it leaves no room for saving or investing, and it can force people into a cycle of debt that's hard to climb out of.

When your cash flow is positive, it's a sign you're in good financial health. It means your bills and debts are paid each month with some left over. Not only does this make life less stressful and give you more opportunity for saving or investing, but a bonus side effect is it can help your credit. That's because on-time payments and low debt balances contribute to an improved credit score.

How to Calculate Your Cash Flow

Monitoring and understanding your cash flow provides a key insight into your overall financial health. And it's easy to calculate your cash flow, especially if you already have a basic budget in place.

Cash flow should be calculated over a set timeframe, such as a month. To start, simply add up all of your net income for the month. This means income after taxes and payroll deductions like health insurance premiums. If you have any side hustles or receive any investment income, make sure to include that too.

Then add up your required monthly expenses, such as your rent or mortgage, utility bills, loan payments, memberships and any other recurring costs. If you're struggling to remember them all, refer to your last few bank statements.

Subtract your expenses from your income, and you'll learn your cash flow. Here's an example: Say between your full-time job and some occasional babysitting, you bring home $3,500 a month after taxes. You add up your monthly expenses and get $3,000. Subtract $3,000 from $3,500, and you're left with $500. That would mean a positive cash flow of $500, and that money could be spent, saved, invested or used to pay down debt.

Alternatively, let's say you make $3,500 in a month but spend $3,700. That indicates a negative cash flow of $200, which increases the risk of missing bill payments or taking on more debt to stay afloat.

How to Improve Your Cash Flow

If you run the numbers and your cash flow is neutral or negative, here are a few strategies you can use to course-correct:

• Create a budget. It's possible to experience low cash flow even if you have sufficient income or minimal expenses. If you're not budgeting or paying attention, it's easy to underestimate expenses and burn through money too fast. Building a simple budget and making sure you stick to it is an easy way to be more mindful of the flow of incoming and outgoing money.
• Cut expenses. Low cash flow can be a sign of overspending, so scour your bank statements and look for opportunities to reduce expenses. This could mean canceling or pausing memberships or subscriptions you rarely use, cooking at home more, switching to more affordable providers or services, temporarily scaling back on luxuries and so on.
• Pay down debt. In addition to cutting back on your spending, you can help your long-term cash flow by paying down your debt balances more aggressively. As you lower your debt obligations, you'll free up more income for other purposes.
• Increase income. As much as reducing expenses helps, you can improve your cash flow on the opposite end of the equation by boosting how much money comes in. Depending on your work, this could mean asking for a raise or working more hours, or looking for weekend and evening side hustles like walking dogs or delivering meals.
• Set aside savings. When you have positive cash flow, avoid the temptation to spend all the money. Make sure to set aside some of it, in an emergency fund or other savings or investment account. Your future self will thank you when unexpected or large expenses arise, since you'll be able to pull from savings rather than take on debt and lower your cash flow.

The Bottom Line

Adjusting your budget and spending to ensure you maintain a positive cash flow month in and month out will help you reach your financial goals more quickly. Money habits that lead to a positive cash flow also often have the positive side effect of improving your credit. If you want to keep tabs on how your hard work translates into better credit, sign up for free credit monitoring from Experian. You'll be able to see how your actions are paying off, while more easily detecting signs of fraud or identity theft.