The difference between ‘Cash flow’ and ‘Income’…
Hey guys,
Had a great question the yesterday from one of my old investors.
“Brett, I just read Robert Kiyosaki’s Rich Dad, Poor Dad’s Cash Flow Quadrant and just wanted to know if this is why you say cash flow rather than just income or rent?”
Funnily enough, I know a little bit about this topic because I have met Robert Kiyosaki a number of times in Australia where I used to work with him during his seminars.
Anyway in short my using the word ‘cash flow’ hasn’t got a lot to do with Rich Dad, Poor Dad although I truly love his concepts and learnt a lot from Roberts philosophies.
Let’s start by explaining my understanding of “Income”. I believe income is the money you earn from a job, it normally comes in at regular intervals and is normally just enough to keep to feed and clothed with a few glimpses of lifestyle. Let’s face it, the very word JOB is an acronym of ‘Just Over Broke’. Not really something that inspires a passionate and enthusiastic attitude to life.
It also really only considers one side of equation
- The input side.
Cash flow says so much more about your financial situation. Cash flow is about both sides of the equation the inputs (or rents) and the outputs (or expenses).
Imagine that you have property that has a rent or income of £500 per month. If all you considered was this side then you might think you are in a great situation. £500 income per month from a property is great but it’s only half the story because let’s now consider the mortgage payments of £450.
You are probably thinking great £50 profit a month, wow I have a ‘cash flow’ positive property.
Cash Flow Positive… hmmm maybe not!
This is the mistake that so many investors make. It’s far from ‘cash flow’ positive because once you must allow or provide for things like letting agents fees, service charges, insurances, void periods, maintenance, renovations etc. You may well find that your cash flow positive property is actually a black hole of despair.
Only once you add all the expenses side of the investment will you truly get a sense of the real cash flow of the property.
Now I introduced a new concept of Allowances or Provisioning in the previous paragraph. This simply means that rather than thinking that my cash flow is positive each month and then being surprised when a bill comes in that I haven’t allowed for. I simply add up the total of all the bills over the period (it could be a year, a decade although I choose 2 years.) Then I apportion the total expense over a monthly or two year period.
Now I mentioned two years, for those of you that know me you will see that I am passionate about my “Two Year Cash Flow rule“.
So let’s say that your service charge was £1200 per year. You will simply divide £1200 divided by 12 months so your provision or allowance would be £100 per month or using my two year cash flow rule, you would allow £2400 over two years.
The £2400 should be put into your high interest provision account or flexible offset mortgage. You should put this aside upfront when you buy or review the property so that when the bill comes in you have the money to immediately write a cheque and pay it.
So before you fall into the trap of thinking that your property is cash flow positive each month, think about if you have allowed for all of the expenses side of the cash flow equation rather than just considering the Income or Rent versus the mortgage payment.
Live with passion,
Brett Alegre-Wood
PS: Just received the first proofing copies of the book. I can tell you it’s definitely one of the most rewarding things I have ever done. More on this soon.