I always thought that hitting a net worth number was the pinnacle of my financial independence journey. While it is important, I realized I (and the majority of the FI community) aren’t hunting for net worth, but a cash flow number. You can have a higher net worth number with very low cash flow stats and that’s just not something that sounds appealing (unless you are convinced sharing your net worth is something that’s going to garner you deep friendships at a bar). “I’m a millionaire” just doesn’t have the same ring to it if you’re still living paycheck to paycheck.
The simple example
A person or business may have a high net worth due to a large amount of assets, such as real estate or investments, but may not have the ability to generate a sufficient amount of cash flow to cover expenses or make necessary payments. On the other hand, a person or business with a lower net worth may have a strong cash flow due to a successful and profitable business. This can allow them to meet their financial obligations, invest in growth, and achieve financial stability.
Let’s say two different people (Jack and Jill) buy properties in Florida. Jack and Jill both put 20% down on their homes worth $400,000 ($80,000). Jack buys a single family home to live in and Jill buys a duplex. Jill rents one of the units to a tenant and lives in the other charging market rent for $1,400.
With no other savings or changes, fast forward 12 months. The average house value went up 9.9% year over year so that means both Jack and Jill both see their net worth increase ~$39,600 to $119,600. The difference is Jill has created an income stream paying for some of her expenses (most likely some of her mortgage here) where Jack is still tied to his W2 income alone. Same net worth. Same number on a piece of paper. Different results and stress at home. It’s not just an example either, top earners see it too.
Cash Flow VERSUS Net Worth
Simply put, cash flow is the movement of money into and out of a business or individual’s bank account. It is a measure of the financial health of a business or individual and is a critical factor in determining the ability to pay bills, invest in growth, and maintain financial stability.
Net worth, on the other hand, is a measure of a person’s or business’s assets minus their liabilities. It is a snapshot of an individual’s or business’s financial position at a specific point in time.
The 3 Reasons Cash Flow is more important
- You don’t have as much control over net worth as you do cash flow. Net worth as a number can fluctuate wildly (see the current market and your 401k). Cash flow can also change, but you have more control over your income streams (rent is set, dividend stocks you select, etc.).
- Cash flow is necessary to meet financial obligations. A company or individual with strong cash flow is better able to meet their financial obligations and has the resources to invest in growth opportunities. Without a consistent flow of cash (for most this is a W2 income), bills can’t be paid.
- Increasing net worth doesn’t mean an increase in cash flow. If there is a focus on increasing cash flow, net worth will inevitably increase (net worth is typically assets – something that makes you money). If the focus is primarily on net worth, there’s a chance your cash flow doesn’t increase.
You can’t pay bills with your net worth
Cash flow is more important than net worth because it is a measure of a business or individual’s ability to generate the funds needed to meet financial obligations and invest in growth. Without a sufficient amount of cash flow, a business or individual may struggle to meet their financial obligations, leading to financial instability and potentially even bankruptcy. That’s an extreme measure, but you get the idea.
Cash flow is the number that I’ve prioritized over net worth because as I increase my cash flow through income producing assets I know my net worth will increase.