The Elements of an Investment
Part V – Cash Flow

Let's look at your personal budget. In that context, we know exactly what we mean when we mention cash flow. We're talking about the difference between the cash flowing in and the cash paid out. But, as one of the nine elements of an investment, what exactly is an investment's cash flow, and how important is it in choosing an investment?

We can define an investment's cash flow in generally the same terms we use to define your personal cash flow, or that of your business. Thus, cash flow is the cash being produced less cash expenditures. Let's examine various investment categories to further illustrate our definition.

A thirty-year Treasury Note provides the simplest example of cash flow. The coupon interest is obviously the cash produced; and, there is no cash expenditure involved in maintaining this asset. Thus, the cash flow is equal to the interest earned on the investment.

A similar, but slightly more complex, example can be found in an annuity. In this case, the cash produced is comprised of predefined principal and interest payments. Once again, there is no cash expenditure, and the cash flow is equal to the annuity's payout rate.

Another factor the above two examples have in common is that the cash flows produced are fixed (unless, of course, if you choose a variable annuity). Hence, while the steady and recurring cash flows might otherwise rate high on our grid at right, they lose points for failing to provide a hedge against inflation. Of course, there are proven techniques for mitigating inflation risk in fixed income investments–and you may improve your rating by employing these.

The cash flow of investment real estate, on the other hand, is usually not fixed, and somewhat more complicated to calculate. Here, the cash flow is most easily determined by taking the net income for tax purposes, adding back depreciation (a non-cash expense) and subtracting mortgage principal payments. Various factors can affect the cash flow. The ability to adjust rents provides you with a guard against inflation. But, better cash flow comes with greater risk: unexpected tenant vacancies or excessive repairs can wipe out this investment's cash flow.

Stocks and stock mutual funds are rather a mixed bag when it comes to rating cash flow. We generally classify stocks and stock funds as "income" (producing regular dividends) or "growth" (small, irregular or no dividends, but with values expected to appreciate). Here again, while stocks in general rate moderately, your individual investment choices can affect your personal cash flow rating.

Although it's the most difficult to conceptualize, your home is also a source of cash flow. When you buy a home using a conventional, thirty-year fixed rate mortgage, you lock in the cash outlay associated with this investment. Then, as your income increases over time, this fixed expense increases your disposable income and your personal cash flow.

Now that we've defined it, what is the importance of cash flow as an element of any potential investment? Like the other eight elements, that depends on your own circumstances, station in life and position in the wealth cycle (see "The Wealth Cycle" in the August, 1992 Financial Advisory). Remember, this is a personalized rating system, and cash flow from an investment may be more important to you than to someone else.

For instance, if you are a forty-year old executive choosing long-term investments, those investments' cash flow may be of little or no importance to you. Right now, your personal cash flow comes from your salary. However, if you are in the midst of your retirement years, the cash flow from your portfolio may be your sole source of income outside of social security. In that case, cash flow might be the most important of our nine elements to you.

Finally, an investment's cash flow rating will also depend on how well that investment rates in the other eight areas. Each element is interrelated, and all nine elements should always be considered when judging the appropriateness of any particular investment.

Elements of Investment
Elements	Savings & Money Markets	Stocks	Bonds	Limited Partnerships	Real Estate	Commodoties	Home
Risk	8	6	7	2	5	2	9
Management	8	7	7	9	4	5	7
Flexibility	4	8	7	1	5	2	7
Liquidity	9	8	7	1	6	1	7
Cash Flow	4	5	6	1	7	1	7
Rate of Return	-	-	-	-	-	-	-
Appreciation	-	-	-	-	-	-	-
Leverage	-	-	-	-	-	-	-
Taxes	-	-	-	-	-	-	-
Total	-	-	-	-	-	-	-

Select Additional Articles from Jerry's Corner The Investment Way of Life Four Cornerstones of Success Excuses... More Excuses The Wealth Cycle Investment & the Wealth Cycle An Economics Primer The Life Cycle Creating A Saving Culture Entrepreneurialism A Fortune in Your Hands Look to the Pros - Introduction - Part I - Insurance - Part II - Stock Broker - Part III - Real Estate - Part IV - Attorney - Part V - CPA The Priorities of Life - Introduction - Part I - Health - Part II - Career - Part III - Relationship - Part IV - Home Elements of Investment - Introduction - Part I - Risk - Part II - Management - Part III - Flexibility - Part IV - Liquidity - Part V - Cash Flow - Part VI - Rate of Return - Part VII - Appreciation - Part VIII - Leverage - Part IX - Taxes

Moorman and Company, an accounting and personal financial management firm based in Palo Alto, serves the San Francisco Bay Area, Peninsula, and Silicon Valley from Hillsborough to Saratoga-Los Gatos, including Atherton, Menlo Park, Los Altos, Los Altos Hills, and Cupertino.