Making a big purchase can make you feel a lot of different things: excited, anxious, unsure. All of which is totally normal, and honestly, it’d be worse if you weren’t having mixed emotions about it!
One thing you can do to help facilitate those bigger purchases, or just help make sense of them, is to focus on two different, but important, areas in your finances: cash flow and net worth.
As a financial planner, I always tell my clients that the best way to build a framework for making large purchases is to take these two important concepts and look at them side by side. Let’s walk through each and talk about their individual importance, and also how they complement each other. This way, you can create a financial decision-making framework to support you through any big purchases!
Cash flow
What is your monthly cash flow?
Cash flow is the amount of money that is coming in and going out each month. Generally, this could be looked at quarterly or yearly, but most frequently we think of it as a monthly indicator. Most people have a good sense of this: they know how much their monthly payments are and they have a good understanding of the money that’s coming in and out.
Understanding your cash flow is critical when you’re looking at what you can and can’t afford. You don’t want to get into a position where you make a large purchase and then can’t afford the monthly payment because it is outside of your cash flow budget.
💸Before you make a large purchase you will want to look at what the impact is going to be on your month-to-month budget.💸
You also need to consider planning ahead from a cash flow perspective. If you or your partner suddenly pass away or you lose your job, you’ll want to have a plan in place so that a monthly payment due to a large purchase doesn’t disrupt your cash flow balance.
This could mean making sure that you have life insurance or disability insurance [link to insurance/home-buying episode] in place in the event of the unexpected happening. You can also consider putting up buffers, like an emergency fund to protect yourself & your family.
The most important part of considering cash flow when making a large purchase is asking yourself the question: Does this big purchase align with what’s important to me?
In my BudgetingBlocks™ exercise, we look at where that monthly cash flow is going using physical blocks to represent your budget, but before we do any of that, we do a values exercise to make sure that it’s aligning with what’s important to you.
I want every dollar that you spend to bring you joy and enhance your life. I want to make sure that when you look back at this large purchase, it brings joy, helps you achieve a goal, and that it’s not something that you have to begrudgingly pay off every month.
Your large purchase should be affordable AND align with your values.
Net worth
What is your net worth?
This is something that people usually miss, and it ends up separating those who are living paycheck to paycheck and those who are actually gaining and building wealth. Your net worth statement is a snapshot picture of what your financial picture looks like. 📸
This is how you calculate your net worth:
Take your assets and list them on one side of a piece of paper. Assets include things like:
- the amount of money in your savings and checking accounts
- your car
- your home
- your retirement fund
- the dollar in your pocket
Line these assets up and add them together.
On the other side of that piece of paper, list your liabilities. Liabilities include things like:
- debts you owe
- credit card balances
- loans (i.e.) your mortgage and car payments
The equation: Assets – Liabilities = your net worth.
This number might be a positive, it might be a negative, but either way, it will tell you where you stand from a financial perspective.
Your net worth isn’t about your month-to-month budget, which is where it differs most from cash flow. It’s about the decisions you make for your overall financial picture.
What might this look like? Ask yourself questions like: Are you spending more on a monthly payment for something when you could be putting that money towards a different financial goal? Like retirement? Or, is all your money in your house?
Having a seven-figure net worth that’s only tied up in one asset, like your home, won’t help you retire, nor will it help with any other financial goal you might have. The best way to approach net worth is to have it divided into several different categories.
The marriage of cash flow and net worth
When bringing these two things together (cash flow and net worth) you create a framework that will help you to make really good financial decisions, including those large purchases.
Having this will help you understand the consequences and tradeoffs of your financial decisions. Try not to think of these things as one or the other — the best decisions come when you think of these two things being in conjunction with one another.
Thanks for tuning in!
Thank you so much for checking out this episode of Everyday Money with Hannah Moore. I look forward to talking more with you about how you can prepare your financial picture for any number of events/purchases.
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Resources mentioned in this episode:
- Use our BudgetingBlocks™ to plan a financial future that includes the highs and lows of the market. A good budget includes all possible financial scenarios and helps you see where your money is going!
- The Everyday Money Values Exercise to help you understand how the most important things in our lives are what drive our money decisions.
- Check out the Everyday Money blog for more ways that you can Identifying and Honoring Your Spending Needs