If you are new to the personal finance universe, there are a few things you will learn. First, it’s basically the same as the Marvel Universe. There’s a lot of infighting and family drama, but at the end of the day, we all just want to save the world. Totally the same thing. The second thing as that we are mildly obsessed with phrases like net worth and cash flow. So what do those mean? Why are they important? And why are PF bloggers so hooked on tracking them?
Net Worth vs Cash Flow: The Official Definitions
To understand why they’re both important, you first need to understand what they are. Both are metrics for measuring your money, but they are for very different things.
Net worth is the number you come up with when you add together all your assets and subtract all your liabilities. It gives you an overall picture of your financial health, and when you compare the number over time, you get an idea if you’re on the right track. What might surprise you is that for a lot of people net worth is a negative number. We carry a lot of debt. This is especially true for a lot of newish homeowners. Many of us (me included) have six-figure mortgages and haven’t had time to build up a lot of equity in our homes. This amount can quickly turn your positive assets (home equity, savings, investments) into negative net worth.
Cash flow is what’s left over after you add up all your income and subtract all your expenses. Usually, it’s calculated as a monthly amount. Just like net worth, cash flow can also be a positive or a negative number. If you have more income than expenses, then you can save, which will, in turn, bump up your net worth. However, if your expenses are higher than your income, you’ll be going into debt every month and this will hurt your net worth. I would argue that cash flow is the more critical factor of the two because it’s the trigger for changing your net worth. An improving net worth is the result of positive cash flow.
Calculating your Cash Flow
Math time, woot, woot. I’m kidding; math is the worst but necessary. I suggest cracking open a brand new spreadsheet. It will be the simplest way to track things and will do the math part for you. If you already have a budget and track your spending, you’ll be able to use that.
If you primarily spend money on a debit or credit card, then you’ll want to pull up your last few months of statements. If you use cash, then this step is slightly more complicated. You need a list of expenses. If you don’t keep one, then it’s time to start. Most of your significant recurring payments (rent, mortgage, insurance, phone, etc.) you’ll likely know so enter those. For the everyday kind of spending, I suggest tracking it for a month and then inputting the numbers.
I like to divide my monthly expense list into the essentials and the non-essentials. This will make it easier to see how you spend your money and reduce non-essential spending if your cash flow number comes up negative.
Highlight that whole column, make it your second least favourite colour and then auto-sum to get your total monthly expenses.
Next, make a new column for all your income sources. Primary job, second job, rental income, side hustle, etc. Then make that column your second favourite colour and again auto-sum to get the total. Finally, subtract the expense total from the income total and that my friends is your monthly cash flow. If that number is stressing you the eff out, then it’s time to get down to business.
Check out these posts for advice on reducing expenses and increasing your income:
The Call That Saved Me $1,200
5 Ways to Earn Extra Money Right Now
The Dreaded Raise Question
Calculating Your Net Worth
Keep that spreadsheet open and create a new tab for your net worth calculation. For this, you need to know the current balances of all your assets and your debts. Pull up your mortgage, student loans, credit cards, lines of credit, car loan, and any other outstanding debts you might have and list them all in one column. Make this column your absolute least favourite colour.
Then gather up current values of all your assets. Your home (take a guess, don’t higher an appraiser), your bank accounts, emergency fund, investment accounts, etc. Enter those in another column and make it your favourite colour. Now sum up both columns and subtract your liabilities from your assets and you have your net worth. Cool beans. This is a snapshot of your financial picture today. Don’t like what you see? Work on increasing your cash flow so you can either save more or pay off more debt and your net worth number will increase. As they say, cash flow is king. Or something like that.
How Often to Calculate?
It’s really up to you. You’ll see some bloggers who post monthly net worth updates, but that’s too often for me. Although it’s easy enough, I don’t exactly love the process, and I don’t think it’s necessary to check in that often. If you are sticking to your budget and have your savings set up to run automatically, then that’s huge. I usually run my net worth calculation annually or anytime there is a significant change in my circumstances. Running it too often can make you stress out about things that are out of your control. Like the markets. Your investments will rise and fall as the market does its thing, but if you’re in it for the long haul, then those month to month variations mean very little.
If you run the calculation annually and it’s improving year over year, then you’re doing the right things. Keep tweaking your cash flow so you’re reducing expenses, increasing income and savings as much as possible (while still enjoying life!) and you’ll see steady gains in your net worth over time. #goals
And guess what? Now that you know you’re a net worth and cash flow tracker you get to be part of the PF Avengers!
This post was proofread by Grammarly.