The author of ‘Practical Steps to Financial Freedom and Independence,’ Usiere Uko, writes about why you need to invest for cash flow
Most people tend to think that when you are rich, you have a lot of money. They judge by outward appearances. Many also believe that when you get to a certain level of affluence, you no longer have money problems.
Continue after the break
You can look rich – drive flashy cars, own houses and be worth hundreds of millions, but be broke and struggle to pay your bills or your children’s school fees. Many people look rich but, behind the scenes, once in a while they shake out their trouser pockets in the wardrobe and look under cushions for money to buy petrol for their car or other necessities. People like this are referred to as asset rich, cash poor. They do not have enough cash. They are living life on the financial edge – if problem strikes, they will have to borrow or sell something to bale themselves out.
Cash flow versus capital gain
Most people look for capital gain when it comes to investing – buy low and sell high, which is well and good. The challenge is; what happens between the period of buying and selling which can be in years? Basically, hope and pray while the item lies fallow rather than generate income. Net worth is calculated based on estimated value rather than actual cash flow, hence one can be rich and still be broke, worth millions but, at the same time, contending with due bills. A minor financial crisis can cause one to dispose of their assets at a giveaway price because they need the money urgently. Negotiating property price with an owner who desperately needs the money is every buyers dream. When they sense the desperation, they lower their bid. They buyer calls the shots.
Cash flow is the lifeblood of every business and personal finance. The moment a company runs out of cash, it is headed for bankruptcy despite projected earnings and profits for that year. You get to hear about terms like “paper profits”, profits not backed by money in the bank. The moment the company cannot make payroll, pay its suppliers and catch up loan repayment, it is gradually going out of business. In mergers and acquisitions, the cash rich partner dictates the terms. You find seemingly smaller companies acquiring bigger companies or becoming the senior partner in a merger. It is a matter of cash. A seemingly smaller Exxon became the senior partner in the ExxonMobil merger, although Mobil had a much larger inventory of facilities. Here in Nigeria, a seemingly small Standard Trust Bank became the senior partner in the merger that produced the new UBA, though the old UBA was bigger in terms of number of branches and customer base. It also holds true for individuals. When you are cash strapped, you negotiate from a position of weakness. He who has the gold makes the rules.
Expert opinions
How much is your property (house, car, etc.) worth? The answer is often an expert opinion. Until the sale is closed, it remains an opinion, which is often on the high side (to make you feel good). You often get much less. The wise investor invests for cash flow while the poor and middle class investors invest for capital gain. They focus more on what they have control over – cash flow. Capital gain follows naturally. More often than not, capital gain is outside your control. Capital gain is driven by market sentiments rather than fundamentals. Your broker can tell you to buy this stock or property now and it will double in price in such and such a time. The broker is just expressing an opinion, not stating a fact. You can buy based on that opinion, and when it turns out to be wrong, you cannot get your money back.
In the real estate market, the true value of your property is the best offer a buyer is ready to pay. Until you see the colour of the money, you cannot say for sure what your property is worth. Even in the stock market where published stock prices are not opinions like the real estate market, a stock may be this price today, but the moment you ask your broker to sell, the price may drop at the point of executing that order. You can feel on top of the world that you are worth this much, but the moment of truth comes when you actually convert your items to cash. For household items, the rule of thumb is to assume it is worth 10 per cent of purchase price. This is one of the key reasons why net worth is not a true indicator of your financial health. The value you put on your item is an opinion. When you invest for capital gain, you are investing based on opinions, not facts. The price movement is not under your control. You can only hope and pray that the market sentiment favours your projections. Your financial plan is based on hope that the opinion turns out to be correct
Cash flow is king
Despite the advances in technology and going cashless globally, the world still runs on cash. You need cash every single day, either yours or borrowed funds. This is why it is critical that your investment generates cash flow (income). Investing is about control. This includes control when you buy and sell. When you sell because you need the money (due to lack of cash flow), you don’t have control – you simply grab the best offer, sometimes amidst much pleading for the buyer to up their offer. You may bluff, but you always come back to the table because you have no options.
When you focus on investing for cash flow, you have control over when you exit the investment. You negotiate from a position of strength. If the price is not right, you can afford to walk away and wait. While waiting, you still enjoy the cash flow from the asset.
Buying and selling looks attractive in the short term, but if you look at the Forbes Rich List, very few, if any made it there by buying and selling. They own assets that generate cash flow. Donald Trump is known for real estate among other things, and much of his wealth comes from real estate holdings. When you keep jumping from property to property (flipping property as it is called), you may make a lot of money in the short term, but 20 years down the line, you may have nothing to show, because the money you made went in directions you cannot account for. If you want to become a flipper, you still need a solid base to flip from, or you may find yourself back to ground zero after a deal gone wrong.
As you gather ‘assets’, look critically at the cash flow component. Don’t tie down your money without generating income. Invest for cash flow. If you run low on cash, you are putting yourself in a financially weak position and may be forced to sell. You can be rich and go broke. Cash flow is king. Do not run out of cash.
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