What Does Cash Flow Mean?

Cash flow is just a term to describe the flow of money coming in and going out. A projected cash flow would be your budget - what you estimate to earn in a given time period and what you estimate to spend.

Why do we want to know it?

First, let me say that we’ve never told a client to cut back on Starbucks, cancel subscriptions or stop eating out. It’s not that we wouldn’t do it, it’s just that most people we work have figured out you need to spend less than you bring in, all while trying to meet your lifestyle desires and future goals. So, we aren’t trying to tell you to reduce certain expenses, rather can your portfolio sustain them. 

We want to know where the money is going in large chunks so we can plan appropriately. For anyone that’s lived past the age of 25, you’ve realized that some of the same stuff gets more expensive the longer you live. That’s called inflation and it’s public enemy number one for retirees. This has become a household term and that’s completely understood over the past few years. But it’s still hard to grasp what prices look like 25 years from now. For example, if you spend $500 on groceries today, that same basket of groceries in 25 years at a 3% inflation rate will cost you $1,046.89 (and that’s a low inflation rate for food).

The more details we know about how you spend, the better we can forecast what you’ll need in retirement, year by year. With that, let’s jump into the different aspects of cash flow and if you’d like to compile yourself, we will tell you where you can find the information..

Sources of income

We need to know the different sources of income, when it starts, when it ends, and any anticipated changes year to year. Here are a few examples:

• Salary - if you’re still working, your current salary is necessary to see what’s coming in as your primary source of income. Your prior year W2 or final paycheck of a year is a good way to confirm this information.

• Bonus - If you have the opportunity for a bonus, is it a dollar amount or a percentage of your salary? How has it historically paid? Is it regularly paid or is it a rare thing to get? Again, a W2 or final paycheck is helpful to understand this.

• Social Security - If you’ve paid into social security and met the requirements to get a benefit, then it usually becomes a significant part of someone’s retirement income. You can always pull a copy of your social security statement by logging on to SSA.gov. If you have a stay at home spouse, they may be able to claim a benefit as well, even though they may not have a social security statement.

• Pension - these are fewer and farther between as most companies are trying to get away from them. But if you have one, you can typically pull an estimated benefit from your pension provider’s website. There are several options usually offered by the pension provider which can be worth the analysis, especially if you’re married.

• Rental Property - if you own real estate and rent it out, this can be a source of income as well. We typically like to understand what you rent it for and what the expenses are for it (property taxes, insurance, repairs). And then we also consider a vacancy rate for renter turnover. You may have an income statement for property or just be able to provide simple details for a quick estimate.

• Investments - This is often the other significant portion of someone's retirement income and the amount of income potential is based on how the investments are allocated. Obtaining statements for each of your accounts is crucial to understand what you hold and how it’s taxed.

Action Item: Find and save your latest paystub, your last paystub from the prior year, a recent pension statement, net rental income, and all your most recent investment account statements.

Debts

Debts can be a hindrance to the retirement equation, but not always. We typically like to analyze all debts to understand the cost of carrying debt (i.e. interest rates), the payment amount, when you took the loan, how long you took it for, and what you took it for. Your monthly debt statements are the best way to get many of these details. Below are common debts that you may have:

• Mortgage

• Home equity line of credit

• Credit card

• Auto loan

• Student loan

• Personal loan - examples include medical bills, home repairs, debt consolidation

• Business debt

• Tax debt

Action item: Find and save the most recent copies of all of your debt statements.  For those debt statements missing the original amount you borrowed or any other info, contact your lender or consider searching through their web portal for that detail.

Taxes

This is the one people dislike the most. While it’s not fun to pay taxes, it’s often misunderstood how much you actually pay in taxes, specifically on the income tax side. There are a few taxes that we consider in a financial plan:

• Federal income tax - This is a big one and we try to control it the best we can based on where your income comes from. Understanding all of your sources of income or potential income helps us plan effectively here. Your most recent full tax return is the best document to understand your federal tax situation.

• State income tax - 43 states have a form of state income tax and 7 states do not. Given most of our clients are in Texas, this is not an issue at this time. If you live in a state with state income tax, then you can review your state income tax return.

• Social security tax - This is primarily focused on the tax you pay on your income that goes into the social security fund. Each individual that is an employee pays 6.2% on their wages up to $176,100 in 2025 (that maximum dollar amount increases each year). Your employer pays 6.2% as well. You may see this on your pay stub (year end gives you the best amount) as FICA or OADSI as a combined number of social security and medicare. 

• Medicare tax - This tax is 1.45% paid by employees and another 1.45% paid by your employer. There can be an additional 0.9% for higher earners. You’ll see this on your paystub.

• Self employment tax - If you’re self employed, then you pay both sides of social security and Medicare tax. That comes out to 12.4% on net earnings up to $176,100 and 2.9% for medicare on all earnings (plus a possible 0.9% if you’re a high earner). Your federal tax return will have this information. 

• Property tax - If you own real estate, you pay property taxes. You should get a statement each year showing your tax for each property you own. That document is helpful, but public records often help as well.

• Capital gains tax - If you sell real estate or investments that you’ve held longer than 1 year, you could be subject to capital gains tax that starts at 0%, but most people pay 15%, and some higher earners pay 20%. Your federal income tax return is a good place to see if this has been paid in the last year. Just because you had capital gains last year, doesn’t mean you’ll have them this year.

• Net Investment Income Tax (NIIT) - this tax comes into play at a 3.8% rate on your net investment income or a modified adjusted gross income if you make more than $200,000 as a single filer, $250,000 for joint, and $125,000 for married filing separately. Again, your federal tax return will have this information and we evaluate it through our planning process.

Action item: Find and save your most recent federal tax return, state tax return, and property tax statements.  For Social Security and Medicare, you can review the paystubs you pulled from the Income steps.

Expenses

Now we get to the place where the everyday items of life exist. This is often where people underestimate what they actually spend. It’s easy to know payments and taxes are a must, but the rest of it can often fall into the background and people are unaware of what this number is remotely close to.

For those that budget well, you likely have a good idea. Most people don’t budget, so it’s unknown. We can help when a client connects their bank account to our planning software and it will auto categorize expenditures (at least to the best of its ability) to get a rough estimate of what you spend. Each month can look different, but your credit card provider likely has something you can review or you may consider using a budgeting app to help analyze. 

Our favorite is pen and paper (ok, it’s actually Excel…) where you can go through line by line of possible expenses you may have. This includes things like groceries, various utilities, auto fuel, insurance premiums (life, auto, etc), tolls, auto maintenance, subscriptions, clothing, dining out, and entertainment. Don’t forget to add in any payroll expenses such as health insurance, group life insurance, group legal, etc.  You can look at your paystub to determine these amounts.

Most people under estimate on the budget and overspend in real life. The point isn’t to spend as little as possible (unless you’re working for a goal that’s more important). The goal is to be realistic so you can realistically plan out your future!

Action item: Review spending through your credit card provider and detail out broad categories of spending on a monthly or annual basis.  Or build a detailed budget outlining your monthly expense (or multiple by 12 to get your annual).

Savings

Finally, we get to savings. You may have a variety of savings such as:

• Emergency fund

• Annual vacation 

• Christmas

• 401(k) - including any company match or profit sharing

• IRA

• 529 education account

• Vehicles

• Investment account

Action items: Review and detail out your recurring savings amounts.  You may know these just from how you operate, or you can pull a year end statement on each account to see how much you saved into it.  For 401(k)’s, review your paystub that you pulled in the Income section of these steps.

You can review the amount you save into these on a regular basis to calculate your total savings amount.

Ideally, if you’ve completed this exercise, you should be able to add up everything in each category and then take your income minus debts, minus taxes, minus expenses, minus savings and the result will be $0. If the number is positive, then you have left over money that needs to be put to work in paying off debts, increasing expenses (if necessary), or increasing savings. If the number is negative, then there is a problem. You have over spent your income and would be going into debt to sustain this lifestyle. You may need to adjust expenses or savings, but if it continues to be zero, it’s not a sustainable way to financially live.  

If you’ve completed all of these steps, then you should have a pretty good picture of your cash flow and most of your future cash flow needs! If you’ve gathered all the documents mentioned along the way and completed the process, you’ve done almost all of the heavy lifting we ask a new client to do as being working together (you can check out our full document gathering list HERE).

If you have any questions don’t hesitate to reach out and we are glad to give you some of our time to discuss!  

If you’re ready to go on to the next most valuable step of planning out your financial future, you can check that out HERE.