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How to Improve Household Free Cash flow
Many people have been feeling the effects of the global downturn for several years now and many people have used this financial hangover to improve their finances. In this hub, I'm going to explain some methods for improving free cash flow within your household.
What is cash flow? Cash flow is the amount of money (or cash) that is received and expended within in a specified time frame. A great way to measure cash flow would be on a monthly or yearly basis. Most individuals receive a static cash flow from their employer in the form of salary. This flow of cash from their employer is fairly 'sticky' meaning it normally does not rise or fall.
Negative cash flow means more cash is going out than what is coming in. Positive cash flow means more cash is coming in than going out. When there is positive cash flow, it can be referred to free cash flow (although there is such a thing as negative free cash flow).
What is free cash flow? Free cash flow is the amount of cash available after income has been received and applied to all expenses due within a given time period. The more cash available, the more you reduce future liabilities, increase investments or create cash buffers.
Both cash flow and free cash flow terms from the business world and are used to measure the health of a business. If cash flow in does not cover cash flow out (e.g. income does not meet and/or exceed expenses), major cash issues will result. These principals can be applied to the household budget.
If you spend more than you make in a given period, you'll have to either not pay a bill, borrow money or increase income/dip into savings. Of those three options, borrowing money is normally the the most taken route. However, when you borrow money to pay an immediate expense, you are reducing future cash flow by increasing the interest payments you will need to make in the future.
Sometimes borrowing money is necessary and can not be avoided. However, getting the liability off your household books as quickly as possible is a priority, as interest charges reduce your free cash flow (both current and future).
Why is positive free cash flow good? Having positive free cash flow means your income surpasses your expenses. That in short means you have left over cash each period. If you use that left over cash to build investments, which in turn kick off capital gains and dividends, you continue to increase your cash flow. Assuming, you also don't acquire more liabilities, you may also be increasing your free cash flow. (The easiest way to think of an asset versus a liability, is an asset produces income, a liabilities does not).
You can also put left over cash into a savings account, which gives you more of a cushion, should cash flow change in the future, and you have negative cash flow. The savings will probably yield some amount of interest, increasing your cash flow in the time being, and provide security for unknown expenses in the future.
A third option, is to use left over cash to pay down liabilities acquired in the past. By prepaying or paying down bills or debts, you're reducing future interest charges, further increasing future cash flow in your favor. The preferred method of paying down debt, is to pay down the balance with the highest interest rate. By doing so, you're reducing future interest payments.
I hope that this article has helped explain cash flow and free cash flow. I also hope you were able to glean some helpful tips on building assets and paying down debt, to help future cash flow. A lot of the information I provided is basic and is common sense. However, some of the easiest and intuitive things we should be doing, are the hardest to achieve.