Where’s your focus…increasing cash flow or net worth?

Where’s your focus…increasing cash flow or net worth?

Net worth is one of the most widely used metrics to report financial progress.  This calculation is commonly used in part because it’s a simple and easy metric to understand and apply:

Net worth = total assets – total liabilities

Your net worth value will provide you with an indicator of your financial situation.  High net worth means your assets far exceed liabilities; that’s a great thing.  Low or negative net worth means you owe significant amounts of debt; not desirable.  Getting out of debt is desirable and there’s many ways to do it.  Monitoring your net worth over time will provide you with an indicator if you’re trending in the right direction but it may not provide you with all the financial freedoms you are looking to fund in the future.

Let me explain…

A house worth $500,000 in Toronto or Ottawa or Vancouver (I don’t think they exist in Vancouver?) has a small consolation prize if you owe $400,000 on that house and have $0 invested.  A house can be a home but it’s also a place to live after all.  Including house assets and mortgage liabilities as part of net worth, while technically correct, is misleading because it says little about the prospects of long term success, much like a small business.  I think a household is like a small business in many ways; you have income and expenses to manage.  In my example above, you may have $100,000 in net worth but if your expenses are equating to or exceeding your income for too long, you’re going to suffer.  Small businesses that have a large net worth on paper might look pretty impressive but if they have meagre or negative cash flow over time, they aren’t going to be in business very long.  A good way of managing your household finances is always thinking like a small business.   For this reason, I suggest investors would be better off focusing on building and increasing cash flow year after year through better budgeting and investing practices, than focusing on net worth.

Years from now, I’ll gladly take the ability for my portfolio to generate money and distribute money over anything else because I can’t spend my net worth, at least not for long, withdrawals from capital only last so long.  On the other hand,  increasing cash flow year after year is like getting frequent raises at work (if you get them), steady, increasing paychecks give you more predictability to plan and live your life how you want.  To me, while a high net worth is impressive and I’m striving for it, increasing cash flow demonstrates an investor’s ability to manage money effectively and efficiently and that’s real financial progress in my opinion.

In closing, maybe I can conclude my thoughts this way – I never want to behave like a spoiled athlete who spends all their net worth.  I’m focusing on increasing my cash flow over time and living within that.  If I do that, I’ll be financially free because of it.

What are your thoughts about cash flow and net worth?  Do you prefer to measure your progress using one over the other?  If you don’t use either measure, which ones do you use to monitor your financial health?

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9 Responses to "Where’s your focus…increasing cash flow or net worth?"

  1. I agree there. Mostly because I have a negative net worth, and I can’t really control the value of my house. I want to increase my cash flow YoY for the next 4 years to reach my goal of a 45% increase in income. It’s a lofty goal, but it’s more motivating to think of the long-term ROI of increased cash flow vs. having a large net worth. I think focusing on cash flow will help my net worth issue as well.

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  2. Most net worth changes come from big swings in the housing market or stock market, which are really outside of my control. I prefer to keep increasing my savings rate and then focus on balancing my net worth so it doesn’t tilt so far towards real estate.

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  3. I focus on cash flow, but I understand they go hand in hand. I try hard to raise my income and not spend the money I make, so that increases my cash flow. And because I try to save and invest as much of my income as possible, my net worth increases with cash flow increases.

    The other way around, if I had a high net worth that wasn’t artificially high by house valuation or another such subjective value, I would have more money for dividend stocks which would increase my cash flow.

    My goal is to make the cash flow so positive that the net worth has no choice but to increase heartily.

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  4. I like to focus on both, but really my main focus would be increasing cash flow, because I strive to do that all the time and investments, for me, are part of that. I check my net worth every few months and aim to increase it, but with so much variability in the various markets, it is harder.

    I try to increase my cashflow, but with a long term focus.

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  5. No one metric is perfect, so I mostly use net worth and savings rate. Sure, there are big swings, but over 6 months or a year, things even out and I have a good sense of how I’m doing.

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