Cash flow and net worth are different things

Two people are paid the same. Over the last twelve months one of them moved 30,000 further ahead. The other moved 4,000 further behind. Nothing about their salaries explains it, because a salary is not the thing that moved.

There are two numbers in every financial life, and almost every argument about money is two people looking at different ones. One of them is a rate. The other is a level. They are related, they are not the same, and the confusion between them is expensive.

The bath

A bath has a tap and a plug hole. The tap is income. The plug hole is spending. The water in the bath is net worth.

The tap does not tell you how much water is in the bath. A wide-open tap over an open drain leaves the bath empty. A trickle into a sealed bath fills it. What sets the level is the difference between the two rates, applied over time — and the level is where you actually live.

Predict

Someone is given a pay rise of 12,000 a year and spends every unit of it. What has happened to their net worth this morning?

Choose one answer

It has gone up by 12,000It is unchanged, and will stay unchangedIt is unchanged today but will rise from hereIt has gone down, because spending rose

Lock in answer

Which unit is the number in

When someone tells you a number about money, the first useful question is what its unit is. If there is a "per month" or "per year" hiding in it, it is a flow. If it is true at an instant, it is a stock.

Not the same thing

Cash flow

What arrives and what leaves over a stretch of time, and the gap between them.

Measured in

Amount per month, or per year

For example

3,200 in and 3,050 out last month, leaving 150.

Chase it alone and

Optimise the flow alone and you can run a healthy monthly surplus for a decade and still own nothing, because the surplus went somewhere that does not accumulate.

Net worth

Everything owned minus everything owed, at one moment. A single subtraction.

Measured in

Amount, at an instant

For example

42,000 of things owned against 19,000 owed, so 23,000.

Chase it alone and

Optimise the level alone and you can hold a large number you cannot reach, and miss a payment on a small debt you could have covered from a week's income.

Which is which? Put each one on a side.

• The 3,200 that lands in the account on the last working day of each month

  Cash flowNet worth

• The 42,000 sitting in that account this morning

  Cash flowNet worth

• The 900 a month leaving the account for a car loan

  Cash flowNet worth

• The 11,000 still owed on that same car loan

  Cash flowNet worth

Watching the level move

The model below is the whole subtraction, run forward. Assets grow, debt is repaid, and net worth is the difference between the two lines. Only one control moves: the amount added to the asset side each year. That is the flow. Watch what it does to the level.

Net worth projection

≈ Hypothetical model, not a forecast

Projects assets growing and debts being repaid side by side, and the difference between them.

It assumes

• Assets grow at a steady rate every year, which nothing real does.
• The saving arrives whether or not the year went well.
• The debt repayment is a separate flow, funded from somewhere the model cannot see.
• Nothing is ever sold, and no new borrowing happens.

It ignores

• Income, tax and the fact that both flows compete for the same money
• Illiquid assets that cannot be sold at the value shown
• Any new borrowing during the period
• Inflation — the whole projection is nominal

Net worth today is 5,000. Move the one flow that is yours to move, and find the yearly amount that puts net worth past 300,000 by year twenty.

Added to assets each year6,000

Net worth today

5,000

Net worth at the end

251,462

Assets at the end

251,462

Debts at the end

0

Year the debt clears

5

Debt clears inside the period

1

• Net worth
• Assets
• Debts

◷ Not there yet — keep moving the controls.

Two things are worth noticing in that chart. The debt line falls to zero in the first few years and then stops mattering. The asset line does almost nothing for a while and then bends. Net worth is the gap between them, so early on it is dominated by the debt and later it is dominated by the growth — the same picture in both halves, driven by completely different arithmetic.

Check

Two people both have a net worth of exactly zero. One earns 200,000 a year and spends 200,000. The other earns 30,000 and spends 29,000. Who is in the better position, and on what grounds?

Choose one answer

The first, because income is what generates wealthThe second, because their flow difference is positiveNeither — the net worth is the same, so the position is the sameThere is not enough information to say anything

Check answer

›Why this confusion is so persistentOptional

Income is visible and net worth is not. You can hear someone's job title across a room; you cannot hear their balance sheet. Every social signal available to you is a signal about a flow, which is why the flow is what gets discussed and the level is what gets guessed at.

It is also the easier number to move. A pay rise is a thing that happens to you once and then keeps arriving. A level has to be built, and there is no single moment at which it happens.

Worth remembering

• Cash flow is a rate, measured per month or per year. Net worth is a level, measured at an instant.
• A pay rise that is entirely spent leaves net worth exactly where it was, in perpetuity.
• What moves a level is the difference between the two flows, applied over time.
• Income is visible and net worth is not, which is why people discuss the wrong one.
• Roughly: a high flow with a zero difference builds nothing, and a small positive difference builds something.