Understanding This One Concept Will Protect You from Going Bankrupt.

CASH FLOW

You’ve probably heard of the term ‘cash flow’, but don’t really know what it is. In layman’s term, cash flow is money flowing in and out of your bank accounts. Essentially, it’s subtracting your expenses from your income (salary + side income).

Cash flow into savings = Income – Expense

In this article, we will take a look at 3 different cash flow situations and how we can protect ourselves from bankruptcy.

1. Worst scenario

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The worst case scenario: Cash flow of some ‘wealthy’ people. Most of the time, they spend more than what they can afford. This is the worst case scenario because their savings are getting lesser as time passes. Eventually, they start borrowing money to pay the bills. Some even declare bankruptcy.

Just ask yourself: What would you do if you hit the jackpot and win a million dollars? If your answer is to buy a new sports car and/or upgrade your house while your monthly salary stays the same, I hate to break it to you but you have poor management of your cash flow. You are spending more than what you can afford. You may appear wealthy at the beginning because of this new lifestyle, but if it isn’t sustainable, slowly but surely, the one million dollars will deplete and you will end up in bankruptcy.

“The easiest way to avoid this situation is just to ensure your monthly cash flow is +++POSITIVE

And that’s it! It’s that simple, if you are spending less than what you earn, there is no way you will end up in a situation where you have to borrow money to pay your bills.

Here’s another question: Is an endowment or retirement savings plan considered an expense?

Ans: Some may argue that an endowment or retirement savings plan shouldn’t be counted as expenses. But if the sum of your loans, bills and savings plan still put you in this scenario, wouldn’t the resulting situation be the same?

2. Typical scenario

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“The typical scenario is to save what’s left from your expenses.”

A typical fresh graduate cash flow: With a take home salary of $2,800, you spend $2,400 on loans, bills and day-to-day expenses. Minus that and you save $400. It may seem like a huge leap from saving $1 a day during secondary school days, but is it really enough especially when we are living in the most expensive city in the world?

How much should I save then?

On the day I signed my employment contract, I asked myself: “How much should I save every month?”

I’m sure this is a very common question most of us can relate to. With many factors such as marriage, kids education, retirement etc to consider, we can never seem to hit the perfect number. If that sounds like you, chances are, you haven’t decided how much you need in the future and are just saving whatever is leftover from your expenses hoping it is sufficient for your future needs.

Taking the typical scenario of saving $400 a month – if we have a milestone ahead of us, let’s say getting married, given the median wedding fees of an average Singaporean which is $32,500, we need 81 months (6.8 years) to save that amount. Even if the fees are split between you and your future spouse, saving for marriage will still take approx 3.5 years. Bear in mind this is only for wedding! Now add in BTO, honeymoon and renovation costs….unless you are willing to settle for something less, saving $400/month may not be the ideal figure.

BE A GOAL DIGGER!

“Setting goals is the first step in turning the invisible into the visible” -Tony Robbins

I’ve done a simple calculation for us to estimate how much we should be saving each month to reach our goals.

Simple illustration

Below is a simple illustration on the expenses of an average Singaporean couple. This is a debatable topic as marriage costs vary for each individual. There are grants given to Singaporeans depending on their income and location of BTO. We also have the option of using our CPF to pay for our BTO. Thus, the actual numbers may deviate significantly based on the points above.

Assumptions:

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You can download the goals calculator for free here.

You may wish to add more columns as you need and the download button is at the top right corner (just in case you can’t find it). With this tool and a little Google magic, we’ll be able to have a general idea on how much we should be saving each month.

From this example, the ideal savings amount is $1,182/month. And to the large majority of us, saving $1,182 monthly isn’t a small sum. Thus, I couldn’t stress more on the importance of spending within our limits. Play around with the goals calculator and see what works best for you. Afterall, we do not wish to fall under the “Worst scenario” category.

Other considerations

If you’ve read my first article, you’ll know that my ultimate goal for us is to retire comfortably by building the five layers of wealth. The earlier we start, the better. Thus, you may wish to consider setting a goal for retirement.

Emergency funds are equally important as we’ll never know when we might lose our income due to unforseeable circumstances (recession, health issues etc). With that in mind, we would also want to build up our emergency funds for rainy days.

These topics will be covered very soon because they form the core of our savings layers.

3. Best scenario

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“Increase your cash flow by budgeting and/or earning more money”

By now, you should know how much savings you need but don’t know how to increase your cash flow.

There are 2 ways. Remember this formula?

Cash flow into savings = Income – Expense

Reducing our expenses, increasing our income or both, will increase our cash flow.

For example, cutting expenses by $800 and earning $500 additional income will increase our savings from $400 to $1,700. That’s an increase of 425%! This not only ensures we are on track towards our goals, we also have additional cash to build on our investment and passive income layers, better preparing us for retirement.

But how? The simplest solution is to gamble save through budgeting, finding ways to cut down on our expenses (credit card rebates, shopback etc) and/or finding additional income.

In summary, with proper management of our cash flow, we will be able to protect ourselves from going bankrupt and with goal settings, we are able to work towards an ideal cash flow situation.

Thanks for reading and happy building your layers.

 

*Featured image credits: Mick Stevens/The New Yorker Collection


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Categories: Savings, The Five Layers

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