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The Concept of Cash Flow

If you have deposited a paycheck of paid a bill, then you have encountered the concept of cash flow. Cash flow simply means the flow of cash through a business or household. In business terms, cash flow involves the flow of cash into a company in the form of revenues, ,and out of the company in the form of expenses.

For an individual or household, cash flow simply means getting income in the front door in time to pay expenses out the back door. Every household manages cash flow on a daily basis. One receives income from his or her employer or some other source, then one uses that income in order to pay bills or buy things that he or she wants.

The Cash Flow Industry

The cash flow industry is a marketplace where businesses and individuals get help managing their cash flow needs. The cash flow industry is all about getting cash into people's hands when they need or want it. One primary way the industry solves cash flow needs is buying, selling, and brokering income streams that are owed in the future.

An income stream is simply how cash flow professionals refer to a future payment or series of payments. Essentially, an income stream is a financial obligation or debt that one party owes to another party. The financial obligation is generally reduced to writing in a legal document. While it is the payments that make up the income stream being bought and sold, they are frequently referred to by the legal document that evidences the payment due. The legal document would also be the debt instrument or cash flow instrument.

Most of the income streams that are bought, sold, and brokered in the cash flow industry are privately held. Privately held means the income stream is owed to a private individual or business rather than to a bank or other financial institution.

Suppose, for example, you sold your home to your daughter and provided the financing yourself. Now your daughter writes a monthly check for her mortgage payment directly to you rather than to a bank. In this example, your daughter's payments create an income stream for you. That income stream is privately held because you are a private individual, not a bank or mortgage company.

The Secondary Market

Privately held income streams, like the one created by your daughter's payments in the example above, can be bought, sold, and brokered in a special marketplace called the secondary market. In the secondary market, individuals and businesses can get cash for income streams that are owed to them in the future.

Let's go back to the previous example. Suppose now that instead of receiving monthly mortgage payments from your daughter, you would rather have a lump sum of cash in order to buy another home. Could you get cash in exchange for your daughter's future payments at your local bank? Probably not. However, you could get cash for this income stream in the secondary market. Many willing investors would give you cash today in exchange for the right to collect those payments over time.

Let's look at another example. Suppose you own a marketing specialties business. You manufacture pens, paperweights, and other gadgets with company logos on them. You have delivered $20,000 worth of merchandise to a customer, along with an invoice requesting payment within 30 days. Although the customer owes you money within 30 days, that money is not yet available to pay your bills or purchase materials.

Now suppose a third party offered to give you $19,500 in cash today in exchange for your $20,000 invoice. Would you accept that offer? You certainly would if you needed cash today in order to pay your employees and buy supplies for new orders. It would make it possible for you to stay in business and keep your customers happy.

Transactions like this occur everyday in the United States and abroad. Individuals collect future payments or income streams sooner, rather than later, by selling them to a third party. The third party pays cash today for the right to receive the payments in the future.

Who are these third parties that purchase income streams? They are called funding sources. A funding source can be either an individual investor or an investment company. Either way, a funding source is a third party that is willing to pay cash today for the right to receive payments over time. In exchange for giving up its cash, the funding source earns a rate of return on its investment.

Just about any income stream, whether it is a mortgage to be paid over 20 years or an invoice to be paid in 30 days, can be sold to a funding source in the cash flow industry. When this happens, it is called a cash flow transaction. A transaction occurs whenever a funding source pays cash to an individual or business in exchange for an income stream.

Individuals and businesses sell income streams for three basic reasons:

1. Access - People need or want access to their cash. Sometimes they have a serious need -- to pay ff credit cards, finance long-term medical care, or to settle a divorce. Other times, they simply have a desire -- to purchase a dream home, take a vacation, buy a new car, finance a wedding, or start a business, for example. In some cases, people want access to their cash just for the peace of mind. They no longer want to worry about liquidity issues, collection hassles, ,or the financial strength of the person who owes the debt.
2. Interest or Yield - People will sell their income streams -- even for less than face value -- because they know that with cash in hand today, they can start earning interest or yield. Interest is what gives us the ability to invest money this year and turn it into an even larger amount next year.
3. Inflation - Inflation eats away at the future value or buying power of money. You can buy more with a dollar today than you will be able to in five, ten, or twenty years from now. People sell their income streams because they realize that, over time, the payments they receive will drop in value.

Buying future payments is a form of investing, and it can be quite profitable. All investors seek to maximize the amount of income their money produces. Buying income streams is one way they can do that.

When investors buy future payments, they earn a yield on their investment. Not only that, they know in advance exactly what that yield will be, provided the payments come in on time as promised. Investors and investment companies are attracted to the cash flow industry because buying income streams gives them the opportunity to invest their money profitably and securely.

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