Doug Fath and Jeff Greco discuss cashflow management of successful real estate investors & business owners in their latest video. Click the video below to watch now.
| Doug Fath: | Hey Doug Fath with Legacy Capital.
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| Jeff Greco: | Jeff Greco, also with Legacy Capital.
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| Doug Fath: | And today we’re going to be talking about cash flow management. And in the prior video when we were talking about financial rituals the final one was the importance of cash flow allocation. And that’s really where free cash flow comes into play and common misconceptions of business owners is they usually focus heavily on profit loss, and just because you make profit doesn’t mean you actually have the cash to spend. Because whatever that net income number is, and again hopefully it is a positive number, that net income number there’s some things that come out of that such as debt pay down. Right, so as a real estate investor, if you have a rental portfolio you’re paying interest every month which does get reflected in your profit loss statement, but then you’re also paying a little bit towards the principle. And so that amount comes down here for paying down the debt that you’ve gotta pay down.
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| Jeff Greco: | And paying down the debt, again if we’re talking about some of our clients that have a rental portfolio or some of our clients who have fix and flip, so paying down the debt if you’re using short term debt, when you sell a property, typically you’re paying off debt or certainly if you have a longer term loan typically you’re paying it off as you go with a portion of each of the rental payments that you collect.
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| Doug Fath: | That’s a great point, and to that point, look sometimes that debt you’re paying down here is required, so in other words when you sell a property you’re going to have to pay that off, but sometimes after you do what’s required you have the option to what you want to do with the free cash flow so maybe there’s additional debt that you want to pay down.
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| Another bucket that you can fill or do with your free cash flow is to build reserves through retained earnings and keep that in the kitty for a rainy day or unexpected expenses or capital.
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| Jeff Greco: | Yeah and each business is a little bit different, right? And we talk about debt or cash flow, sometimes there’s general business debt and then also in our business there’s specific debt on a specific property. At the end of the day, depending on what scale your business is operating at now and really what level you want to play at or grow your business will determine on what level reserves you want to have.
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| So sometime people say, “If I have a few months of reserves I feel good.” Some people, I think it was Bill Gates who said, when he was building Microsoft, he wanted 12 months of reserves when he was building. So, the reserves is, look it’s going to rain or in today’s case it’s going to snow. But at the end of the day reserves are for when those unforeseen things happen. As business owners we may not know when, but if you were in business long enough some things that you don’t plan or don’t expect are going to happen so the question is how do you have a safety bucket? Or how do you have a strong enough foundation so that those things don’t put you out of business?
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| Although, there may be a temporary setback, or given market conditions, if you have reserves or if you have enough saved up, actually if the market takes a turn for the quote, unquote worse, are some of the best buying opportunities. So really what we’re alluding to in this video is not only how you distribute your free cash flow, but actually how you tie this into having a strong business, no matter what the external market conditions are or what specifically may be happening in your business.
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| Doug Fath: | And the other option with that free cash flow is you can invest that. And with the clients that we work with these are growth minded clients, they’re scaling their business, so their focus is on growing and investing those dollars to build a bigger business. And so oftentimes there’s this rub, so to speak, between you want to have the reserves so that you’ve got that foundation and sort of balancing the reserves as well as with the desire to grow and invest those dollars. And both are super important for your business and as Jeff said, though, you certainly want to make sure that you have those reserves taken care of because you’ve got that strong foundation.
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| And the stronger the foundation the actually easier it is to invest and grow and scale rapidly once you’ve built that strong foundation, which includes how to invest [inaudible 00:04:38] reserves.
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| Jeff Greco: | And sometimes people like to skip to the invest step with stepping over the reserves step and we can speak from personal experience, that they’ll have times where it’s always great to invest as you know you’re building wealth and you know that everything’s going to create a lot of money at some point in the future, and what we’ve found is that … through experience, that there’s some lessons that maybe we didn’t want to learn at the time. Actually having reserves and maybe taking a little longer to invest, but as long as you have your reserves you can actually ramp up your investment activities a lot quicker, if you do build the reserves first and fill that bucket.
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| And then you can essentially be unlimited with how much you can invest rather than thinking, or staying up at night, you know, “What if something changes? Am I going to be able to handle it?”
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| Doug Fath: | And through whatever reason, on my personal experience of my rental portfolio, when I first started I didn’t have these reserves, and when I didn’t have these reserves it seemed like I needed it all the time, there was always an issue and something going on. And since I’ve actually built the reserves not only can I sleep better at night, there’s confidence there’s a strong foundation, but now that I have the reserves it seems that I rarely need to use them. So it’s important to have that and as Jeff said, sometimes people want to skip over the reserves to get straight to invest. And then the other thing that we found and this is usually more … Again going back to the four stages of a business owner, it’s usually that first stage of a real estate business owner, they skip this one. They skip this one and they go right to this one. To distribute. Where they’re looking to essentially distribute income or distribute those surpluses directly to themselves right away, ’cause maybe they need it to live off of, they’re trying to move away from their job, whatever the case may be.
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| And look, as business owners, let’s be honest we’re all in this business because we want that distribution to be as big as possible and there’s also a time and a place for when that distribution really becomes appropriate, and the point that Jeff was making is if you’re able to … the longer you’re able to defer making that distribution, provided that you’re building the reserves and you’re investing well, this distribution should be significantly larger the more you’re able to defer it. As opposed to if you paid it out immediately from day one.
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| Jeff Greco: | Right, so just hold off from telling your friends around the happy hour table how much money you’re distributing from your business to start. Build up your reserves, invest and next year when you come around you’ll be able to tell them you’re distributing a multiple of what you thought you’d be able to.
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| Doug Fath: | Exactly. And look, I mean that’s Warren Buffett, the greatest investor in the world, that’s exactly what he’s done and what he does. He continues to … he’s got the reserves, right, he’s always sitting on a pile of cash and then he’s an amazing investor and cash flow allocator. He keeps investing rather than distribute, investing investing, creating more wealth and creating more piles to distribute when he wants to.
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| Jeff Greco: | So make money, allocate your cash wisely.
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