Most people tend to think that when you are rich, you have a lot of money. 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. I know some people a while back who looked rich but used to shake out their trouser pockets in the wardrobe to look for money to buy petrol for their car. People like this are referred to as asset rich, cash poor. They do not have enough cash.
Most people look for capital gain when it comes to investing. Net worth is 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 past due bills. A minor financial crisis can cause them to dispose off their assets at a giveaway price. Negotiating property price with an owner who desperately needs the money is every buyers dream. When they sense the desperation, they lower their bid. The buyer calls the shots. He who has the gold makes the rules.
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, the company 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. Smaller cash rich Exxon became the senior partner in the ExxonMobil merger (Mobil was asset rich and cash poor). Here in Nigeria, smaller cash rich Standard Trust Bank (STB) took over asset rich but cash poor UBA and retained the UBA name for brand recognition purposes. It also holds true for individuals. When you are cash strapped, you negotiate from a position of weakness. When there is no dime in your pocket and your bank account, your self esteem suffers, no matter how exotic your automobile or which neighbourhood you live. You live life on the edge, always afraid that something will give. You are not far away from embarrassment.
The real rich invest for cash flow while the poor and middle class invest for capital gain. More often than not, capital gain is outside your control. Capital gain is often a perception driven my market sentiments. Capital gain is on paper, an opinion based on what the market is saying at that point in time. It is only realized when you cash in. Since the value placed on an asset is often an opinion, the reality is that you often get less when you cash in. Opinion is often worlds apart from reality. 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 asset is worth. Even in the stock market where published stock prices are not opinions unlike 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 assets to cash. For household items, the rule of thumb is to assume it is worth 10% of purchase price. This is one of the key reasons net worth is not a true indicator of your financial health. The value you put on your asset 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.
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 for when the price meets your exit parameters for the investment. While waiting, you still enjoy the cash flow from the asset. When you invest for cash flow, you usually get capital gain as a bonus. For example if you own a rental property, you get cash flow from rents, and the property can also appreciate in value. You are not under any pressure to sell. That goes back to the common sense definition of assets – anything that puts money in your pocket, in essence eating your cake and having it. If your investment does not generate cash flow, you are putting yourself in a financially weak position. When you invest for cash flow, you hardly go wrong. Cash flow is king. Do not run out of cash.
– Usiere Uko is editor of www.financialfreedominspiration.com and author of Practical Steps to Financial Freedom and Independence – www.amazon.com/Practical-Steps-Financial-Freedom-Independence/dp/147006832X .
