21 June 2011

Why Managing Cash Flow is So Important to Your Investment Process? - Part 3



From my previous posts - Part 1 and Part 2, I have explained the reason why I think that managing cash flow is important to your investment process and I created a spreadsheet to show you that finance ratio to guide you in monitoring your fiance ratio / strength so that you are sleeping well during the recession and fully utilize it when the market turns uptrend/downtrend in one day. Here I am illustrating to you how cash flow should work.


Explanation:

E = Employee
S = Self Employed
B = Business
I = Investment

Each of the oval represents the different cash flow movement. For Employee, your cash flow inflow is basically your fixed salary + bonus and your cash flow outflow is basically your living expense and other investment.

For Self employed person, your cash flow inflow is basically your commission / consultation fees / professional services that requires you to work more hours to gain more cash flow inflow. Of course, you also have outflow, such as possible litigation fees against others and interest paid out etc.

For Businessman, your cash flow inflow definitely is your business income. After deducting the operating cash flow, then it is your free cash flow that allow you to re-invest or distribute it to your shareholders.

For investor, your cash flow inflow definitely is your capital appreciation as well as your dividend income / rental income / passive income.

To have a very healthy cash flow, you must be in at least 3 out of 4 in this circle so that you are able to generate the cash flow in a 'triangle' mode instead of single mode. Let me give you a good example:

Person A is an employee of a Big Company XYZ. He has salary of 60K annual salary including bonus. For this reason, he has sufficient savings after deducting all his living expenses such as insurance, car loan, mortgage loan and entertainment etc. As age growing, he felt unsecured as he thought that his salary cannot grow much and he has the risk by replaced by younger, more energetic guys in his company. He quickly find a financial adviser / fund manager / accountant to get a good investment plan. However, a good investment plan also has its risk as he is worried that he will get no passive income during recession period. He decided to open a small business by writing blog and publish his own books. Now, with 3 ovals (E, B, I), he can now enjoy his life while working happily in his current company.

In next post, I will illustrate in more detail on cash flow movement above.

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