written by KCLau @ KCLau’s Money Tips
This article analyze the movement of income and expenses with line chart illustration. Watch the movement closely and plan ahead for unforeseen circumstances.
During this whole week, I will be posting with a lot of charts that illustrate mainly about our cash flow and net worth. I will start this series with income and expenses flow. Examining the pattern of your cash inflow and outflow is the most essential part of determining your financial well-being.
Ideal Income & Expenses Flow
Let’s look at Figure 1. It shows an ideal movement of income and expenses of a person’s entire life.
Figure 1: Well planned Income & Expenses Flow Chart
Section A: Learning Phase
Learning phase started since the day we are born. In fact, it never ends because learning is a life long experience. But for this case, let’s say a person need 20-25 years of education to be equipped with the skill to earn a decent living. During this phase, our life is sponsored mostly by loving parents. There is no income generated and most people find that it is the best time of their life. No worry about money. No major commitment. This result in:
Outflow > Inflow
Section B: Accumulating Phase
When we started our first job on the first day after graduation, most of us got excited when the first paycheck came in. If you are money smart, spend less than you earn so that you can build up your net worth. This is a period when we work hard for a good career or business. Expenses increase later as we get married, own a bigger house, buy better cars and provide education for our children.
Let’s call it the accumulation phase. It ends when we retire, or at the time we achieve financial freedom around age 40-65. For those who didn’t fall into credit card debt:
Inflow > Outflow
Section C: Retirement Phase
When we finally retire, or forced to retire, active incomes drop to zero. We carry on our life with the passive income generated from our previously accumulated assets. We have to do proper budgeting so that we won’t be spending too much. If we spend the principle sum from our retirement funds, the fund might decrease hence reducing the passive income generated. In order to stay financially independent:
Outflow = Inflow
Ideally, this is what we expected for average person. For the rich, income shoot up at a higher rate. Their passive income is at a very high level (proportionately). So the green line actually didn’t drop after they retire. That’s a perfect chart that everybody dreams to have.
Now,let’s zoom in to examine a shorter time frame. The short term cash flow of 1-3 years might not have too significant movement.
Figure 2: Examine a shorter time frame
Unforeseen Circumstances that Affect Cash Flow
Ideal plan is a plan that goes exactly as pre-determined. But life is full of uncertainties. Life is also full of risk. We never know what will happen tomorrow. This is what makes life the greatest adventure we won’t miss. There are many unforeseen circumstances that will affect our cash flow
Figure 3: Unemployment effect on cash flow
During economic down turn, a person might lose his job unanticipatedly. Income suddenly drops to nil. At the other hand, outflow still goes on. Instead of having a net saving at the end of every month, there is a deficit that eats into our nest egg.
Preparation: Build up an adequate emergency fund. Losing a job is just a temporary issue. If you still have your ability and skill set, getting a new job is just a matter of time.
Illness or Disability
Figure 4: Illnesses and disability effects on cash flow
This is something even worse than unemployment. A person will lose his earning capability, at least temporarily if lucky enough that it is not a permanent disaster. Saving is replaced by even higher deficit. Having an adequate emergency fund might not be enough. The better solution is to transfer the risk to someone else who can afford it.
Preparation: Insure yourself, and all those family members that depend on your earning to survive.
Besides the above unwelcome events, there are many other major issues that is not mentioned here, including natural disasters like flood, fire, earthquake etc. Don’t underestimate the risk of your family members too. When your next of kin need your help, you can hardly refuse to lend a hand. Your hard earn accumulated wealth might not be yours.
Summary for Action
1. Draft the ideal income & expenses flow chart. You must plot it the way that you want it to be. It is better to even include the exact amount of income desired and compromise on expenses. Mark the details such as earning $50,000 at age 25, $100,000 at age 30, $200,000 at age 40 etc.
2. Study and analyze the past history of your cash flow chart. Create a proper budget that you can live with. Find out the unforeseen event that had impacted your financial situation before. Learn from your own experience.
3. Get prepared for any unavoidable impact on your cash flow. This includes getting your life insurance reviewed, insuring your major assets (house, car, theft protection etc), and also building up an adequate emergency buffer.
4. Tightly monitor your cash flow. Review it often. Use some software to help you and do it as frequently as possible, probably every weekend or every first day of the month.
Did I miss out any major point? Share with us your valuable opinions.