24 June 2011

Why Managing Cash Flow is So Important to Your Investment Process - Part 7

In post 6, I have briefly mentioned that CFI, CFF and CFO is a very important cash flow in your investment process. Hence you will have to master how to mange those 3 cash flows in order for you to grow your investment portfolio in long run.

The details of CFO, CFI and CFF in our investment process would be explained in details in this post.

Below are the cash flow movement in between those cash flows. I shall explain it right now:

Your Net Operating Cash Flow now flow into Investing Cash Flow. That means your income in operations (such as Salary Income, Business Income, Self Employed Income and Rental Income will be used to purchase or invest in assets or financial assets. Hence although your cash flow now is reduced, however, you might be able to produce a bigger cash flow in future as you have invested in the assets that might give you more income.

The Interest Income, Dividend Income as well as Capital Gain will be flowed back to your Operating Cash Flow and make you feel more secure and the cash flow would support you in your daily life. You may save some portion of your cash in the emergency fund in case of any.

If we are lacking of operating cash flow, what should we do to purchase the assets? We can actually borrow money from bank or financial institutions to purchase the assets. What kind of assets we can purchase using Financing Cash Flow? The common one is the mortgage loan that allow you to purchase a real estate. It can be up to 80% or 90% for your 1st purchase of the property. So, please do not waste your time to accumulate operating cash flow too long. As I mention, time is money, so it is good that you can use Financing Cash Flow to leverage in your investment. You may also use margin account for short term leverage if your skillset is there. My personal advice is to not leverage too much in futures account as the volatility is much bigger than real estate. Please take note that, the larger the financing cash flow flows in today, the larger interest that we need to pay in later date. Hence, managing this type of cash flow is very important. Please do not too optimistic on your cash flow management.
Of course, if your financing cash flow become bigger and you are worried that you cannot afford it, then you may liquidate some of your investment to repay debt to bank / financial institution.
Some time, we can also use Operating Cash Flow to reduce the impact of the interest that we need to bear. My advice is, try to use CFI to cover CFF, so that your CFO can grow in healthy way. Of course, there will be some circumstance that you have to use CFO to reduce CFF. So, always be prepared for the worst case scenario while stay optimistic on your CFI.
This type of cash flow (from CFF to CFO) is typically for business income and self employed income. The businessman and self employed person can take a business loan / personal loan to grow their business and hence make the operating cash flow better. Of course, as I mentioned earlier, the bigger Financing Cash Flow is, the bigger interest we need to bear. It may cost a financial burden or distress to a business if we add in too much debt in our daily portfolio.

In conclusion, the three cash flows movement will decide how your cash flow is. Please be very careful in managing your cash flow in your investment process. Enjoy Investing!


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