If you ask an investment manager what the foundation of financial success is, they'll say it's a solid Investment Policy Statement. Ask an insurance agent, and they'll tell you that it's the right insurance policy. Ask a CPA, and they'll say that it's a good tax strategy. Ask a banker, and they might tell you that it's a good savings account or CD. And while all of these are very important, none of them are truly the foundation of financial success. No, that honor belongs to cash flow management.
Let me say that again: cash flow management is the foundation of financial success.
But what exactly is it? Why is it important? And how do you master it? Good questions.
What is cash flow management?
Simply put, it's the art of:
Spending less than you make, and
Pointing your money in the direction you want it to go.
Some of you may have already mastered #1 without trying very hard, through a combination of being well-compensated for your work and having little desire to "keep up with the Joneses". And when you get down to it, #1 by itself will get you quite far!
#2 is critical, however: to shop or invest with intention, to allocate your resources as optimally as you can, balancing giving, spending, and saving in the best way you know how. Why? I'll tell you.
Why is cash flow management so important?
Cash flow management is the lynchpin that holds everything else together.
With good cash flow management, you can handle most threats and opportunities as they come, allowing you to effectively self-insure for "the small stuff". Without it, minor issues become catastrophes, and opportunities pass you by.
With good cash flow management, you know where your money is going -- and you're OK with that. (You may not be happy that 20% of your income is going to pay off your debt, but you made that decision conscientiously, with the knowledge that it'll put you in a better place in the future.) Without it, your money just kind of...wanders off. Creating an involved IPS or spending hours optimizing your savings is worthless if you have thousands of dollars of high-interest debt!
With good cash flow management, summer vacations and Christmas don't cause anxiety (at least, not because of your finances), because you've saved up over the course of the year and are careful to stay within the budget you established. Without it, Christmas comes as an unpleasant surprise...which is ironic, because it arrives every year at exactly the same time.
In short: with good cash flow management, you are the master of your money. Without it, it's the other way around.
Now, those of you who just sort of naturally spend less than you make may think you're in the clear. You're not. It only takes a little work and creativity to be intentional about where your money goes -- and it'll reap dividends you likely can't even envision now. More on that in a bit!
Tools for mastering cash flow management
If you're looking to get good at the fundamentals, there are some great resources out there. Below are just a few that I highly recommend. (And no, I'm not affiliated with any of them -- but I have at one time or another used all of them!)
Dave Ramsey: Let me begin by saying that my colleagues and I have very mixed feelings about the renowned financial expert. On the one hand, his "envelope system" is an excellent cash flow management technique that has gotten countless households out of debt. On the other, he has said things about mutual fund selection that have made us cringe. Regardless, his Total Money Makeover book is a great place to learn about cash flow management, and where it fits into your overall path to financial success.
You Need A Budget: YNAB is an excellent online program for tracking your spending and creating (and following) a zero-based budget. (Want to know what a zero-based budget is? Check out their Four Rules.) Moreover, they have a ton of (free!) online courses and guides to help you along the way.
Simple: Simple is an online bank that is designed from the ground up to help you manage cash flow. Elegant and, well, simple, it's great if you want your bank and your budget tightly integrated.
The 50/20/10 rule: This guideline comes in several flavors, but 50/20/10 is Seaborn's variant. The short version: spend no more than 50% of your after-tax income on non-discretionary expenses (including minimum debt payments), no less than 20% on saving, investing, or debt payments over the minimum, no less than 10% on giving, and the rest on whatever you want. This provides you with a decent starting point for figuring out a balance between flexibility, savings, giving, and your desired standard of living. For more details, check out our full 50/20/10 writeup.
Yours/mine/ours: If you share finances with someone else, I strongly urge you to consider a system like "yours/mine/ours" accounts. Implemented properly, it can greatly cut down on money-related marital strife!
Your creativity and imagination: This is the biggest and best tool in the box, so I saved it for last. Good cash flow management involves figuring out what your priorities are. Not what's "important" and what's "not important", because yes, I know, everything is important. No, it involves figuring out what's most important. What is it that you really value above everything else? What is it that's important, but ultimately comes in last place when compared to your other priorities? Align your money with your values, and you'll be astounded at what happens.
It also involves looking into the future and imagining the things that might happen -- good and bad. Are you setting money aside for car maintenance, medical emergencies, and job loss? Are you budgeting for the things you really love?
A mental exercise: what would you do if you had a yearlong paid sabbatical? (After you finished binge-watching your favorite shows, of course.) Would you travel? Sculpt? Paint? Write? Start a business? Good financial planning is the art of making that happen, as soon and/or as often as possible, and cash flow management is the cornerstone of good financial planning.
Got a dream in mind? Good. Now comes the creativity part: figuring out how you're going to get there from here. Dave Ramsay's famed quote is this: "If you will live like no one else, later you can live like no one else." All it takes is to be willing to do things a little differently, to think a little harder and outside the box, to prioritize things not according to What People Do, but according to how you value them.
You'll be amazed at what can happen. I know I was.