During the late 90’s and early 2000’s DMX was on top of the world. He reportedly sold over 30 million albums, starred in numerous Hollywood feature films and at one point even had his own reality show. Then, in 2013 he declared bankruptcy with an estimated $1,000,000 to $10,000,000 of debt. Similarly, many celebrities seem to fall into this cycle of fame and bankruptcy all too often. So how does this happen? Although it’s often complicated, it always filters down to problems with their cash flow and net-worth. While we’ll likely never be famous, these celebrities can teach us some valuable lessons.
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A cash flow statement is simply a comparison between your income inflows, such as work pay or investment income, and expenditure outflows, like utility bills and rent. The difference of the inflow and outflow can be either positive, when your income is greater than your expenses, or negative, when you’re paying out more than you’re taking in. So when you have a positive cash flow, your wealth is growing and when it’s negative, it’s shrinking.
The time period that is used for recording cash flow is typically a month or a year in duration, but it can be whatever is most convenient for you. Personally, I find that using a weekly cash flow is very helpful because it’s a good estimation of my spending and it’s not overwhelming to monitor.
A budget is essentially a planned future cash flow statement in which you compare your income to your expected expenditures over a time period. Then, any remaining amount is saved for another time.
A net-worth statement is how much you possess in assets after you deduct what you owe. In accounting, this is calculated by subtracting your liabilities from your assets. As with your cash flow, this can either be positive or negative. So for example, if you have assets, like a home or savings account that total $500,000 and you owe $300,000 in liabilities then you have a net-worth of $200,000.
Your net worth is an accumulation of your past cash flow and is generally how much you have saved for your financial goals. Also, if you have a negative cash flow then your net worth can be used to pay for the increased cash outflow.
Many other bloggers like to comment on why cash flow is more important than net worth and vice versa, but this is really a waste of energy, as they are both vital to one’s personal financial health. You need to have a positive cash flow to increase your net worth and your net worth is the road to your financial goals. A strong net worth can also protect you against times of decreased cash flow.
Going back to our bankrupt celebrity, DMX, he had a large income flow, but an even greater expenditure outflow. This negative cash flow ate away at his net-worth and eventually thrust him into bankruptcy. Although this situation is unfortunate, it offers us all a chance to reflect on our financial position.
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