To Measure Wealth: Focus On Cash Flow, Not Net Worth
Most CEOs, founders and entrepreneurs know why they set out on their business ventures. Many speak of autonomy and noble causes like providing better processes and innovating industries. The mandate for business is to create success through financial freedom, which contributes to our definition of wealth. Interestingly, though, we seem to mostly gauge each other’s wealth by asking about net worth — some arbitrary figure based chiefly on an accumulation of assets (property, automobiles, jewelry, art, etc.). However, a more accurate indicator of wealth or success and financial freedom is cash flow. So, what’s the difference?
Why Net Worth Is An Insufficient Indicator Of Wealth
The concept of net worth is mistakenly worn as a badge of honor. In simplest terms, the definition of net worth is assets — your savings, home equity and investments — minus liabilities, or what you owe. Let’s say you own a home worth $200,000, and you have a mortgage of $150,000. Your net worth is $50,000. Seems simple.
The value is an assumption until the property is sold. Finally, the equity or net worth of the property is not liquid — meaning you couldn’t get the money today or as quickly as if the money was in your bank account. The point is, net worth is an estimate of your wealth based on the best guess of value.
Cash Flow As A Better Measurement Of Wealth
Business owners understand cash flow. Cash flow is the money coming in and going out of your personal and business accounts on a monthly or annual basis. The money coming in could be from income, sales, profits, new investment and debt payments. Cash flow is a real-time measurement of financial health.
Unlike net worth, cash flow is liquid and stable. It is also predictive and future-oriented. If you have positive cash flow, you can pay expenses, have a cushion in the event of an emergency or plan for future investment opportunities. These wealth streams are cash, and cash is king.
So, how do you increase cash flow to increase your wealth?
Diversify Your Income In Three Ways
Most CEOs, business owners and entrepreneurs already know something about moving from a W-2 to a K-1. As an employee, we get a W-2 at tax time; it means we earned a wage. As a business partner, we get a K-1 at tax time, which means we made a profit. In a quote often attributed to Jim Rohn, an American entrepreneur, he said, “Wages earn a living. Profits earn fortune.” The goal is to earn profits.
To capture a steady stream of profits, you must diversify your income streams. The average multimillionaire has at least seven streams of income. Diversity historically comes in three ways: earning, portfolio and passive investments. The earning is self-explanatory. You provide labor, sell a service or a product and earn an income (or profits). The second is where you traditionally save or invest in CDs, index funds, stocks, bonds or savings.
Then there is passive income. Passive income is where your money makes money while you sleep. It can come from traditional methods; however, savvy investors are now earning these types of returns through crowdfunding, venture capital, syndications as well as other mainstay investment methods like real estate.
Considerations When Building Cash Flow
The velocity of money, or how fast money changes hands, is a key consideration when building a cash flow stream. You want to make sure the money you earn is quickly reinvested into more income-producing opportunities. Also, you don’t want to have too many eggs in one basket. Spread your money around so if one investment or stream of income dries up, you still have others to fall back on.
Also, consider your risk tolerance for income streams. Some income is more stable than others. For example, dividend-paying stocks are more stable than stock options. However, you may want to consider taking on a bit more risk for the potential of higher returns.
The final consideration when building cash flow is tax planning. Make sure you are aware of the tax implications of each stream of income and how to best structure them for optimal tax savings.
Five Steps To Increase Your Cash Flow
1. Maximize your earned income.
2. Create a source of portfolio income with stocks, bonds and equities.
3. Create a source of passive income starting with real estate.
4. Optimize tax efficiency.
5. Double down on your financial and investment education.
Finally, consider my article a piece of financial inspiration, for knowledge that leads to action is wisdom. Creating a financial fortress may require time and energy, but success loves speed, so make sure to act on the ideas you have read above: Set a cash flow goal, choose a vehicle and get started now.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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