The dreaded “B” word drums up a lot of emotions in people. Often budgets are associated with cost cutting or even financial failure or bankruptcy. However budgets are by businesses and other successful people to establish a spending plan and to map out their financial future. Budgets are a useful starting point in establishing your financial plan but they are narrowly focused and typically only look at your expenses.

I like to establish a cash management plan that looks at your cash flow needs over time that can then be used to establish a strategy to meet your needs. The cash flow management plan will help you tie in your household net worth statement and net worth goals.

Cash Management Planning 101

In my article on net worth planning I showed you how to prepare a household net worth statement. The household net worth statement measures the value of what you own and what you owe at a single point in time. On the other hand, the cash flow statement tells you where your cash came from and where it went over a period of time.

Note that net worth can only grow if cash flow is positive or if you have savings. Savings are positive when the annual cash in flows exceed the annual cash out flows. The accumulation of savings is why we use cash management planning as one of the key financial tools.

If your savings over a period are not adequate to achieve your household net worth target, then steps must be taken to correct the situation either by increasing income or reducing expenses. If your adjustments still do not help, you must re-evaluate your net worth goal.

If you are generating savings cash management planning can help you set a higher net worth target and then meet the target with higher savings. On the other hand, If you have inadequate savings techniques you can use to improve your cash flow include:



Control your current expenses by restraining spending on discretionary purchases such as coffee at the local shop or buying lunch everyday at work.

Restructuring your debts



Consolidating high interest credit card debt

Refinance your home to lower interest expenses or payments

Discard or discontinue credit cards

Defer big ticket purchases





Reposition assets to improve cash flow by postponing the purchase of:



Non-essential consumer goods (i.e. that fur coat)

Non-income producing investments like gold, coins, or art

Negative cash flow investments in leveraged real estate or other investments requiring long-term periodic payments







Preparing A Cash Flow Statement

The starting point for cash flow planning is the cash flow statement. The statement looks much like a budget and if you have never done a budget before you will need your bank and credit card statements to determine your historical cash receipts and disbursements (I include credit cards because many times people substitute credit cards for cash).

Looking At Your Cash Flow Statement

The main objective of cash management planning is to find out how adequate your savings are to meet your net worth objectives. Net worth targets can be refined to include investment, educational and retirement funding objectives. Cash management planning helps achieve these goals systematically.

Cash flow planning helps you identify flexible (i.e. discretionary) expenses and fixed (or non-discretionary) expenses. Also helps you understand your situation and identify any excess spending and control cash outflow to a more desirable level. Note that the flow statement will not cover every single cost. Many of us have very large “other” out flows of cash that are unexplained.

If you have kept a monthly budget and stayed on target you are on the right track. However, the budget is only a part of the equation and the key to long term success is the development of a systematic savings strategy. The savings strategy includes specific plans to generate required savings, systematically direct savings to specific financial goals.



Thanks to Dean Paley for contributing this article to our Factoring blog:

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I assume that being profitable is a stronger statement tha being cash flow positive - correct? Can you be profitable and not cash flow positive? Vice Versa?

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I don’t have any money for down payments, my income is low, (about 3,500 per month), my credit score is low, and I’m in the process of selling my home in a short sale. I want to create this cash flow as a means of supplement income and then eventually my main source of income. Is this doable?

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One of the most misunderstood and commonly mistaken terminologies in real estate is cash flow. Every person and every business requires cash flow in order to survive. The question to ask is: what kind of cash flow are we talking about?

When I first started real estate investing, I remember this scenario as a perfect example of how a novice can misunderstand the principles of cash flow and land up in big trouble a few months later. Here’s the story:

We received a call from a business associate just starting out in real estate. He called to run the numbers by us to make sure the deal was as good as it looked on paper. He was buying a pre-sale condo and there was huge cash flow: a thousand dollars a month. We let him gush about the deal in order to vent his emotional fervor. This was red flag number one. Emotions never dictate a deal: only fundamentals. He was going to make a lot of money. Or so he thought … until we started asking him some clarifying questions.

What type of cash flow is the thousand dollars? Is it gross income, effective gross, NOI or net? Gross Income is the rent. Effective Gross Income is rent plus other income such as laundry and parking and less vacancy allowance. NOI, an acronym for Net Operating Income, is gross rent less operating expenses. Net Cash Flow is NOI less debt service. Debt service is your mortgage payment. Net Cash Flow is the bottom line and for me, this must be positive cash flow.

What is positive cash flow? This is the continuous flow of money over and above expenses and debt service that is deposited into your account every month just like a pay cheque. Positive cash flow equals freedom.

Less than five minutes later, we figured out quickly that our friend had neglected to deduct strata fees, property taxes, utilities, repairs and maintenance, factor in a vacancy allowance and – most importantly – his mortgage payments.

From a passive income perspective, the deal was a money drain. He would have been subsidizing the condo about $500 per month. This comes to $6,000 out of pocket expenses a year later. He didn’t have the fortitude to flip the property a year later.

Cash flow is intimately related to expenses. Both cash flow and expenses need to be managed and strategized. Some provinces have rent caps. Alberta has no rent caps which makes it an attractive place to buy investment property. Even so, the market dictates the rent amount. In an uptrending market, rents should always be managed up.

What are two types of expenses: operating and capital. These are some of the fixed operating costs associated with properties:

• Property taxes

• Property insurance

• Property management

• Utilities: water and sewer

• Utilities: electricity and oil & gas

• Repairs and maintenance

• Maintenance service contracts

• Refuse removal

• Vacancy allowance

• Advertising

• Bank charges

• Contingency allowance

A mortgage is not an operating expense. This is a debt service.

These are some of the capital costs associated with properties:

• Hot water tank

• Roof repair or replacement

• Appliance replacement

• Carpet replacement

• Electrical system upgrade

• Fire code upgrade

Capital expenses are capitalized. You cannot deduct 100% of these expenses all at once. This means that only an allowable percentage of the capital expense can be deducted each year similar to the capital cost allowance deductions for automobile deductions.

Owners of multi-family dwellings have a choice between creating an operating or capital expense. How? Suite by suite repairs and maintenance such as replacing the carpet and painting can be expensed. Replacing the carpet throughout the building and common areas or painting the entire building is a capital expense. These decisions are made in conjunction with our Bookkeeper and Chartered Accountant.

One of the most important calculations is the investor’s bottom line: their Cash-on-Cash Return. This is calculated using the Net Cash Flow per year and divided by the actual cash investment. Although this is not a true reflection of their total return on investment, it is a very powerful and compelling reason for investors to participate in your investment.

The next time you encounter cash flow issues, you have your clarifying questions to determine what type of cash flow you’re dealing with.



Thanks to July Ono for contributing this article to our Factoring blog:

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Given an Accounts Receivable turnover of 8 and annual credit sales of $362,000, the average collection period (360-day year) is: how many days?

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