In the previous post I pointed to some issues with net worth as a metric. This leads to the question "What should I be tracking instead?" The answer should not surprise you, as you likely already track it unconsciously: cash flow. Cash flow is composed of two measures: your income, and your expenses.
Cash flow is the make-or-break crucial chain in finances, especially in personal finances. If you're mindful of your finances already, you should be able to recognise when you've spent more than you've earned. If you consistently spend more than you earn, you will soon find yourself broke and bankrupt.
The big picture of cash flow is recognising whether you have positive cash flow coming into your finances, or negative cash flow leaving your accounts. In other words, whether you're making money or burning money.
Debt is the most common form of burning money. Debt's cash burn is difficult to recognise unless you are comfortable looking at the numbers, but just because you can't see the flames doesn't mean it won't burn you. If you're carrying debt, then Mr. Money Mustache has a crucial message for you: you are in an emergency, act like it!
So why track cash flow if it tells you what you already know? Well, once we've established positive or negative cashflow, we can dive deeper into the details for greater understanding of our financial positions--and our personal habits.
Take for example these three cash flow reviews, and let's see if we can assign narratives to each one:
The first we see is someone living paycheck to paycheck. Without breaking down the expenses into categories, we can't say why for certain. They could be a student paying off loans, or a debit-only big spender, and so on. What's notable is that their savings rate is low--around 5% every month.
Second is someone with a good savings rate--but only for half the year. Perhaps they save up for vacations and travel, or perhaps they are getting slammed with big ticket bills. Either way, when you average out their expenses, their savings rate plummets down. Despite looking better than the first example, they're still in a precarious position.
The third is something vastly different--someone who makes boatloads of money in bursts. Usually people like this come in the form of contractors and freelancers, and they must exercise tight control of their finances to weather the famines between erratic feasts. However, close examination of this particular example shows that our hypothetical contractor has a weakness: extra spending just after being paid.
All three examples exhibit different levels of financial control. Yet when you balance out the total income against the total expenses, you'll find that they're all saving about the same amounts. Which means that they're all on similar tracks for retirement after several long decades.
This is why I consistently turn to cash flow for my own finances: it reveals our savings rate. This is not just a measure of progress towards retirement, but a safety factor that allows us to weather unexpected bills. The savings rate is also controllable, as you can cut down discretionary expenses to increase your savings rate.
Your discretionary rate is the complement to your savings rate: it's a portion of your expenses, whereas savings is a portion of your income and the remainder after expenses. Discretionary expenses are able to be slimmed down to scrape through lean times. You can choose to skip your normal spending habits when you recognise that you need to--but to recognise that need, you should be tracking your cash flow.
There are many ways to track it, and as with most of life it doesn't matter which way you choose. It matters more that you get started at all.
You can sit down at the end of a month, add up all your income and add up all your expenses. Or you could track the total amount of money left in your accounts at the end of every month, and look at the difference between months as the cash flow. Either way, you're now tracking your cash flow!