Cash Flow vs Net Worth

Which of the two would you prefer to have? High cash flow or high net worth?

Before you decide, let us define what cash flow is, and what net worth is. The simplest definition of cash flow is the difference between cash inflows and outflow. Net worth is the total assets minus total liabilities of an individual or company.

Note that this is a simplified explanation as accounting terms take depreciation and taxes into consideration. For our purpose here it’s sufficient.

An example of net worth.

Assets
House 100,000
Car 10,000
Cash 5,000
Stocks 5,000

Liabilities

Mortgage 80,000
Loans 5,000
Credit card 5,000

In the above example, your net worth will be 30,000 (120,000 minus 90,000). If you to create a higher net worth, you acquire more assets and reduce your liabilities.

Cash Flow

Income
Yourself 2,000
Spouse 2,000
Rental income 300

Expenses
Home repayment 1,000
Car expenses 500
Entertainment 500
Food 500

Your cash flow is 1,800 (4,300 minus 2,500).

Most people aim for a high net worth as compare to cash flow. If you aim for net worth, you will get net worth. You hear it all the time. Mike is rich. He has a high net worth.

What’s the danger of just looking at net worth alone?

1. You might end up with assets that don’ generate income. If there is unexpected changes in you income or expenses i.e. the cash flow, you could be in trouble.

In the example above, in good times you have an additional 1,800. But if your spouse decide to quit or worse, got fired, you’ll end up with a deficit of 200! This deficit will have to come from your asset, it will reduce your cash, or you have to sell your stocks or even your home. Otherwise, your lifestyle will need adjustment. No more entertainment or cut in food expenses. Very painful way.

If you additional income from rental, or royalty or business of say 200, then you will not have a deficit. You need not change your lifestyle and have time to look for another job or build a business.

2. You could own assets that depreciate or nobody wants them. Say you have a car that you purchase for 5,000. If you want to sell that car and the market value is 2,500 the car is actually worth 2,500 even though on paper it is worth 5,000. Some assets aren’t worth anything.

3. Everything depends on your income or your ability to earn money. If you are a self employed professional or independant contractor, the moment you stop, your income stop.

On the other hand, if you have a sizeable positive cash flow, you could channel that money to purchase income generating assets, or reduce your liabilities.

So is having a high net worth a bad thing and a high cash flow a good thing? It depends. With high net worth, depending on what you own, you can convert assets to income generating assets. If you have “nothing” i.e. zero net worth, it will be harder.

When looking at your financial well being, check both your net worth and your cash flow. Look at ways to increase cash flow and convert some of you assets to generate income for you.