Controlled cash flows can help you build wealth

Cash flow constitutes of cash inflow, cash outflow and surplus or deficit that is occurring. Cash inflow means money that flows in and cash outflow means money that flows out. Only earning income and incurring expenses doesn’t account as cash flow management. Cash flow management means understanding the components from where the money comes in from and where the money goes out to. Now the question is why is it important to have a cash flow statement? This is because you would understand from where the money is coming and where it’s going. It will help you understand whether you are making any unnecessary expenses or if you are paying more debts than your cash flow permits.
 
Cash inflow involves
Income that you receive in the form of salary, bonus, rent, business or investments. There are some ways in which you can control your income like working for long hours or taking up an additional part-time job, switching jobs, etc. However, in most of the cases, the control over your income is limited.
 
Cash outflow involves
The cash outflow can be divided into two major sections viz. fixed expenses and discretionary expenses.
 
Fixed expenses
These are the expenses which most of the time cannot be tweaked to your liking. In fact, fixed expenses are the expenses which you cannot ignore. Expenses such as rent, school fees, EMIs, salaries, transport, electricity bills, mobile bills, groceries, medical and hospital bills, etc. are expenses that you cannot avoid.
 
Discretionary expenses
Discretionary expenses are the spending that can be avoided. So you have complete control over these expenses, unlike fixed expenses. Expenses such as shopping at premium brands store, dining out very often, spending on vacations, etc. are the expenses which you may avoid by your choice and you have complete control over it.
 
Savings
Savings is the cash which is actually left with you post deducting fixed as well as discretionary expenses from your income. This is the section which shows you how much is your surplus or deficit. Savings are the only part in the cash flow which would show you how much you can invest to create wealth.
 
So the more you invest more the wealth you can build. So to attain this either you have to increase your income or decrease your expenses, especially your discretionary expenses. So let us go through an illustration which would help you to understand this concept.

So in the above table, we have considered that all things remaining the same in both the scenarios except that we have reduced discretionary expenses by Rs. 1 lakh in scenario two. So now we will invest both the surplus amounts in mutual funds, specifically large-cap equity mutual funds for the period of five years.
 
So if we invest Rs. 2 lakhs for five years assuming an average rate of return on large-cap equity MFs is 12 per cent. Then at the end of the fifth year, your value would be Rs. 3.52 lakhs. On the other hand, if we invest Rs. 3 lakhs in the large-cap equity MF assuming 12 per cent rate of return, then at the end of the fifth year, our value would be Rs. 5.28 lakhs. So we have reduced the discretionary expenses by 33 per cent and this allowed us to create 50 per cent more wealth.
 
So from the above example, we can understand that if we are able to reduce our unnecessary expenses then over the period it will help us build wealth. However, we are not against spending. All of us earn to spend. However, it is very important to channelize those spending and decide priorities. This will help you spend in a controlled manner and make available investible surplus to create wealth.