CASH-FLOW MANAGEMENT BIASES

Cash-flow management is a very important system that teaches prudence and limiting risk exposure. It is essential for one’s financial survival. On the other hand, it is quite a limiting approach, with some “slippery slopes” to avoid.

Changes in your cash inflows and outflows typically have little to do with changes in your overall wealth. Let’s look at some mathematics that show why this is so.

(First, an explanation: ∆ = the Greek letter delta, often used to mean “change.” So, for example, “∆Wealth” means “change in wealth.”)

Wealth = Assets – Debt = Income – Expenses

Wealth = Assets – Debt – Income + Expenses

∆Wealth = ∆Assets – ∆Debt – ∆Income + ∆Expenses

∆Assets = ∆Cash + ∆Property + ∆Inventory + ∆Other Assets + …

∆Debt = ∆Mortgage + ∆Credit Cards + ∆Payables + ∆Other Debt + …

∆Expenses = ∆Living Expenses + ∆Education Expenses + ∆Financial Expenses + ∆Other Expenses + …

∆Income = ∆Salary + ∆Other income + …

This all leads to:

∆Wealth = ∆Cash + ∆Property + ∆Inventory + ∆Other Assets – (∆Mortgage + ∆Credit Cards + ∆Payables + ∆Other Debt) – (∆Salary + ∆Other income) + (∆Living Expenses + ∆Education Expenses + ∆Financial Expenses + ∆Other Expenses)

As you can see, cash is just one of the many things that affect your wealth. So, managing cash can have only a (very) limited effect on your wealth.

In my professional life, I’m often asked, “You claim that I’ve made a huge profit; if that’s so, where is all the money?” Business people also experience problems in understanding their own wealth. The answer to that is, “Just look at that last long equation, buddy.”

Being rich and being wealthy can be two very different things, even on a simple financial basis.

Apart from the straightforward mathematical approach to debunking the alleged super-importance of cash-flow management, we can also observe some psychological biases, products of our modernity…

Leave a Reply

Your email address will not be published. Required fields are marked *