Money Lesson #1: Basic Finance, Cash Flow, and Risk Management
A few nights ago, it dawned on me that being the sole handler of our family finance is our biggest liability. That is a huge risk, if something ever happens to me. Even if I take out an insurance policy large enough to support her and our son, it will not help if she does not know what to do. Basically, she will be stranded.
Photo by Genista via Flickr
As any good businessperson would do, I created a risk management plan. I discussed this risk with my wife, and we agreed that I should teach her money management; specifically our family finance.
This post will be the first in a series where I share with you the learning journey that my wife and I are taking. Our first lesson revolved around finance and cash flow basics. Here are the points I covered with her:
Finance Basics
I first posted about finance basics in Wealth building made REAL simple. I told her that the foundation of our finance can be grouped into 4 categories:
- Revenue – This is the money that flows into our family. Our revenue sources consist of my salary, her wage, investment income, and the money that my parents and her brother give us for their share of household expenses (we all live together in the same house).
- Expenses – This is the money that flows out. Our expenses consist of taxes, housing expenses including utilities, transportation, food, clothing, insurance, health-related expenses, entertainment, etc.
- Assets – These are money that we own in various shapes and forms. Our assets include our house, cars, savings, investments, and other items of value.
- Liabilities – This is money that we owed to other people. Our liabilities include of our home mortgage, car loans, and credit card debt.
Cash Flow Basics
- Good Cash Flow – If we manage our money well — i.e., keep our revenue higher than expenses — we will have excess cash. We can save this money and buy more assets that can appreciate and generate more income.
- Bad Cash Flow – If we do not manage our money well — i.e., our expenses exceed our revenue — we will add to our debt, or have to sell some assets to cover the expenses. Either case, we are eroding our wealth and its growth potential.
Well, this was all I got in before she fell asleep. I will have to work on being a more captivating teacher. How do you think I did for the first lesson? I think my next lesson will be about financial goals.
If your spouse does not know anything about your family finance, I invite you to join me on this learning journey. I also encourage you to leave a comment, or blog about your own lesson.
Give them the gift of education today, so that they have the financial intelligence to survive without you.
Other lessons:
- Money Lesson #1: Basic Finance, Cash Flow, and Risk Management
- Money Lesson #2: Setting Financial Goals
- Money Lesson #3: Investment Vehicles
- Money Lesson #4: Choosing the Right Tool for the Job
This article was featured in:
- The Personal Finance Money Tips – October 6, 2007 hosted by KCLau’s Money Tips. For more information please visit the Personal Finance Money Tips Carnival.
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I really need to follow along with you as you do this with your wife. Between myself and my husband, I’m the one who’s financially challenged, knowing how to spend but not really knowing how to develop a way to pay down the debt so we can enjoy more of the cash.
The last five years we’ve been married have been torturous financially. We’ve accumulated a lot of debt, maybe not so much in dollars, but in quantity of creditors we owe. This includes medical expenses during all the years we couldn’t afford health insurance. It also includes the 4 or 5 credit cards I helped my husband over-extend.
I suppose I’ve never been any good at at realizing I can still eat Top Ramen when I have some extra cash and save instead, rather than buying steaks and wine just because I have extra cash. He knows how to do all of this. He grew up this way. Yet I’m still of the mindset that I should make each day as comfortable for myself and family as I financially can without losing the roof over my head.
However, here’s the page turner: I just landed a job Aug. 31st working for the State making more than he and I were making before together. Okay, so now we have the extra cash coming in. Now I just need to know what is the smartest way to manage it.
This, Pinyo, is why I need to follow along as you patiently teach your wife the things I need to be taught also. I don’t want to screw it up again for us financially. I feel like we finally got the big break we needed. Now I just have to know what to do with it!
Hi, I think you are doing very well. Maybe you can add in some chart illustration to show her how money flow. Such as using the cash flow chart and net worth diagram.
I’ve written a post about hacking the charts.
http://kclau.com/2007/08/29/ha.....rth-chart/
@Chris – thank you for sharing your story, I think yours is very typical of Americans’ lives. Medical insurance is definitely a big problem in this country. At this rate, it will soon surpass housing expense as #1 expense for typical American. That’s very scary.
Also, overspending is a very easy thing to do. With all the advertising and marketing to lure us to spend, and the convenience of credit card.
Congratulation on your new job. It is definitely a new chapter and a chance to start fresh. I welcome you along on my journey!
@KCLau – Although I do not think very highly of Robert Kiyosaki and Rich Dad Poor Dad, I have to admit there are some part of his book that was insightful — as noted in my review about his book.
Overall, I think you did a great job with your post at simplifying and demonstrating the cash flow concept. It was very easy to understand.
Hey Pinyo, could you help clarify something for me regarding your REAL simple categories? I’m having trouble seeing what the dividing line is between an expense and a liability. When you said this above ” If we do not manage our money well  i.e., our expenses exceed our revenue we will have more debt, or have to sell some assets to cover the expenses…”, would the category “liabilities” also be part of this equation?
Liabilities must also decrease your net worth, along with expenses; however, I think I’m having trouble differentiating between what is an expense and what is a liability. Is a liability something that is not a basic necessity to live, such as credit cards, auto loans, etc., yet an expense is a roof over your head, food in your stomach, and lights to see at night with? Or are expenses and liabilities all basically the same thing when it comes to whittling away your personal worth?
Hope I don’t sound like too much of an idiot, I just want to be sure that I’m following along with you and understanding every iota!
Thank you, Pinyo.
Chris – it’s a good question. It’s hard to differentiate because they are related. First, you can live WITHOUT liabilities (debt is a better word, but I didn’t want to call my diagram READ). For example, you don’t need car loan to buy a car, student loan to go to school, credit card debt to use the card, nor mortgage to buy a house (hard, but can be done).
Second, expenses are money that you need to spend to survive — e.g., food, shelter, clothing, medicine, etc. — or because you have to — i.e., taxes.
So what I tried to explain was, if your expenses are very high and you can’t afford it with your income, you will have to take out loans to cover your expenses (or sell what you already have to pay for those expenses).
Did that help?
Yes, Pinyo, that helped a lot. The word “debt” cleared it all up for me. To recap, debt is something we actively have chosen to incur whereas expenses are inescapable, whether we choose to have them or not, i.e, taxes, food, medical care. It is a fine line, sometimes, because we might deem it an expense (or necessity) to find a way to work and so we incur a debt (or liability) by financing a vehicle in order to fulfil the “need” of getting to work.
Thanks, Pinyo. Looking forward to lesson #2. (I hope your wife is, too!)
Chris — almost. There are two type of expenses. Expenses for NEEDS — these are necessary and you can’t avoid them — e.g., food, shelter, etc. And, expenses for WANTS — you can avoid these — e.g., Starbucks coffee, iPhone, HDTV, trip to Paris, etc.
In business it is often not lack of income that kills a business but the lack of cash flow. You can have all the income in the world but if people aren’t paying up and you don’t have the money in the bank then it doesn’t matter. I believe that the same is true of personal finances and it is often what leads us to have to use credit cards etc because of poor planning.