Most of us dream of achieving financial freedom. Getting out of the rat race. Taking control of our lives. Retiring early, spending more time with family or even starting our own business. Financial freedom is the choice to do what you want with your time.
While the vision of financial freedom is different for everybody, the path to achieve it is the same. The journey to financial freedom begins with achieving positive cash flow.
Positive cash flow allows us to create an emergency fund, pay down consumer debt, acquire income-generating assets and ultimately achieve financial freedom.
What is cash flow?
Cash flow is very simply the money remaining each month after expenses are paid.
Typically we are considering monthly cash flow or monthly income minus monthly expenses.
Positive cash flow is when your income exceeds your expenses, where as negative cash flow occurs when expenses are greater than income. Achieving a positive monthly flow is an absolute must.
What can you do with positive cash flow?
1. Create an emergency fund.
Sadly, many people can’t afford to incur an unplanned expense of even a few hundred dollars without accruing additional credit card debt or worse. These unplanned expenses represent a real “financial emergency”. A minor financial emergency might take the form of an unplanned car repair, medical bill or pet expense. While a significant emergency might be losing a job or going on disability. In any case, these types of events are stressful and often unavoidable.
Maintaining an emergency fund is absolutely essential.
A small emergency fund of one thousand dollars can be sufficient to cover minor financial emergencies and can provide piece of mind on a daily basis. For larger emergencies, such as loss of employment, it is recommended to have at least three months of income available. While it can be daunting to think of saving three months of income, positive cash flow is the key.
2. Pay down debt.
At a minimum, positive monthly cash flow allows us to avoid the death trap of accruing credit card debt. Better yet, positive cash flow can be applied to eliminate existing consumer debt.
Consumer debt includes credit card debt, mortgage payments on your primary residence, personal auto loans, and student loan payments. Consumer debt is cash flow kryptonite.
Reducing (or eliminating) monthly expenses from consumer debt is the first step to generating cash flow and achieving financial freedom.
3. Acquire income-generating assets.
Once you have paid down consumer debt in order to maximize your monthly cash flow, you can begin to acquire income-generating assets. Obviously income-generating assets increase your monthly income, resulting in event more cashflow.
When discussing cash flow, it is important to understand that there are different types of income. The most common type of income is earned income, but there is also portfolio income and passive income.
- Earned income is money that you typically earn from an employer such as your salary, tips, bonuses, etc.
- Portfolio income is money generated from investments in stocks, bonds, etc.
- Passive income is money that is generated from real estate, business investments.
While earned income from an employer is often fixed in the form of a monthly salary, portfolio income and passive income may vary depending on things like interest rates, stock prices, rental rates, etc. The primary benefit of both portfolio income and passive income generating assets is that you don’t need to spend much of your time physically working on them to achieve a recurring income stream.
4. Become financially free.
When passive income exceeds monthly expenses you are financially free. You can quit your day job and do whatever you want knowing that you have recurring income each and every month without the need to work a 9-5 day job. Of course you can choose to keep working if you want to.
For most people, positive cash flow generated from passive income streams is the only way to true financial freedom for life. Sadly, many people are only looking at their net worth (savings accounts, retirement funds, home value) and wondering if this will be enough money for them to live on during retirement years. Recurring cash flow is the answer to this. You’ll know that you have new income coming in each and every month, without needing to deplete your reserves and worry about the longevity of your savings.