Cash flow is a key indicator of your financial health.

In this topic, you'll learn:

>The definition of cash flow.

>How to improve cash flow by increasing income and/or decreasing expenses.

>How to use the Step-Down Principle.

Your cash flow is the difference between the total amount of money transferred into and out of your bank account. Typically calculated monthly, it is what's left over after subtracting your outgoing expenses from your income.

For example:

Income - Expenses = Cash Flow

$6,000 - $5,000 = $1,000

Cash Flow = $1,000

In this example, the cash flow is positive, meaning more money is being earned than spent. Having a positive cash flow is what budgeting is all about - then you can save or invest the extra money as you work towards achieving your financial goals.

On the other hand, if the figures in our example were reversed, the cash flow would be negative since more money is being spent than earned. An occasional month of negative cash flow here and there is normal (that's what emergency funds are for). Still, a negative cash flow month after month is a problem for anyone. Once savings are spent, going into debt is the next step. 

If you find yourself in a situation of negative cash flow, remember that there are ways to turn it around. You can explore opportunities to increase your income and/or find ways to decrease your expenses. 

Budget and Cash Flow Analysis

If you don't already maintain a budget, this website offers tools to set up a monthly budget and track your monthly spending. Another approach is downloading your past few months checking and credit card account transactions. For each month:

  • Export your transactions to a spreadsheet.
  • Sort the transactions by name. For checks, consult your checkbook register or account statement to identify each check and update the name to reflect the payee.
  • Cut the deposits from the list and paste them into a new sheet.
  • Cut the fixed expense payments and paste them into a new sheet. Examples include loan payments, rent, mortgage, and insurance payments that are the same every month.
  • Review the remaining transactions for required expenses that vary, such as utility bills, gas, and groceries. Paste them into a new sheet.
  • Use the auto-sum tool to total the amount column for each sheet.

You'll then have a rough idea of your income, essential fixed and variable expenses, and nonessential discretionary spending. Remember, spending can vary monthly - unexpected bills, vacations, and holiday gifts can be unpredictable. So, tracking your spending over time is essential to understand your cash flow. This can help you identify patterns, areas where you can cut back, and opportunities to save.

Increasing Cash Flow

For those new to monthly budgeting, aligning income and spending with goals is key. Increasing income or cutting unnecessary spending can free up more money for savings, paying down debt, or any other purpose. 

A few ideas to increase income could include:

  • Ask for overtime.
  • Find a second job.
  • Sell something.
  • Review your paycheck withholdings. Getting a large refund each year means too much is being withheld. But be sure to consult with an accountant before making changes.
  • If available, take advantage of income tax programs, such as the Earned Income Tax Credit.
  • Try entrepreneurship or working in the gig economy.

A few ideas to decrease expenses could include:

  • Review monthly bills for places to save (unused health club memberships, streaming subscriptions, cable television).
  • Get quotes from different companies on your insurance policies.
  • Avoid recreational shopping.
  • Use the public library for books and movies.
  • Shop at less expensive stores.
  • Use a programmable thermostat.

For many more ideas, review our Money Saving Ideas topic.

The Step-Down Principle

The "step-down" principle is a great way to find, reduce, and even eliminate unnecessary expenses. The big idea is to make changes slowly and to avoid feelings of deprivation. Otherwise, it's easy to make a change for a limited time (like a New Year's resolution), but old behaviors almost always come back.

Here's how it works:

No matter what you're trying to change, you start with where you're at and slowly take a step down. You take another step down once you're comfortable with that new step. You keep doing this until you've reached your desired behavior.

Imagine a staircase with five steps. The top step is the most expensive way to purchase an item. The bottom step is the least expensive way to buy the same item. For example, the most expensive way to purchase clothes is at an expensive retail store. The least costly way would be at a thrift shop. On the steps in between, there are likely places (or times) where you could purchase a similar item at a lower cost - buying out-of-season clothes on sale, choosing a less expensive store, or shopping at a consignment shop for gently used items. 

Determine where you are on the steps and take one step down at a time so you don't feel deprived.

This principle also works with spending frequency. For example, if you buy lunch every day at work, you could take one step down and bring your lunch one day per week. Once you're comfortable with that, try bringing lunch twice weekly. 

With some creativity, you can likely find many applications of the Step-Down Principle in your everyday spending. And those small changes do add up over time!