Cash Flow Paradox

Many seem to pay little attention to the importance of managing cash flows. And many others ignore the fact that a main reason behind managing cash flows is to set an effective reinvestment strategy. If money was saved at a normal saving rate, and then kept as a deposit in a bank with a fixed low rate or even invested in real estate with best chances of getting 15% as annual rental income; no great fortune will be accumulated. For that, money have to grow at a compound rate that might involve all of the above besides many other investments. In the book “Puzzles of Finance”, Mark P. Kritzman discusses the tradeoff between safe and relatively unsafe investments. He mentions there how different investment strategies can yield different returns. His final conclusion was that an investor is better off if his money was invested in a safe investment like real estate, then a relatively unsafe one like stocks, then again somewhere safe, then unsafe, and so on. If his conclusion was to be assumed valid, how can one manage that?

Financial planning is vital for individuals, households, companies, and governments. And proper financial planning means knowing where the money comes from, how often, how stable is the cash flow, and what should we do with the accumulated cash flows. In the marine industry, for example; the wide range of products from boats to mega yachts creates two different types of cash flow curves: the mild and very frequent against the steep and not too often. The former, since it’s the more stable, is used to manage and pay for the regular monthly expenses such as rent and salaries. The other type of cash flows, which are quite big in amounts, are used best to spend on all sorts of investments. The logic here is that yachts are not sold all the time, and to safe guard the first type of cash flows, the income from other investments such as real estate can help mitigate the risk of an unstable series of cash flows. Also, and in other industries, similar examples might be seen whenever there is a range of products that differ greatly in price.

With small businesses, the previous scenario is way less complex. The trick remains in knowing how to stabilize your cash flows as much as possible in order to pay expenses on time and to be able to reinvest. Reinvestment, on the other hand; is a totally different story. To master that, one must be able to compare and contrast the different options that one got beforehand. For reinvestment to work at its best, one must realize that money is supposed to be circulated in different loops of safe, neutral, and unsafe investments that intersect at different optimal in-and-out points to ensure maximum effectiveness towards accumulated wealth is achieved. In other words, money shouldn’t be at any point static. Finally, and at early investment years, an individual must invest and reinvest excess cash flows rather than spending them on luxury products. For start-ups, cash should be invested to grow. This explains why a no dividend policy is healthy if stocks were, at any future point, publicly traded. It means that there are opportunities to grow.

To conclude, there is no manual with specific guidelines on how individuals or companies should manage and stabilize their cash flows. There is no such thing as an ideal reinvestment strategy that guarantees maximum possible return. Every individual is unique in terms of priorities and how they accept or reject risk. The same goes for companies and how risk tolerant they are. What’s important here is to understand why stabilizing cash flows and reinvesting them efficiently is essential. When such a concept becomes contagious in an economy; the economy will be moving towards being more stable in terms of its ups and downs. Credit will be better understood to be better used by individuals, established companies will invest in research and development to create better sustainable technologies, and the right investments in both examples will enrich the jobs market. Now remember here that what a bank pays doesn’t normally match the unannounced inflation rate and that only “with great risks come great returns”.