You work, you earn it, you spend it, you save it, you invest it for the future, and you keep it under the mattress. How do you know it’s going to the right places and helping you build wealth over your career?

Think of how you might assess the ocular health of your patients, using various tests and tools to assess the health of your patient’s eyes and strength of vision. 

You go through acuity tests, refractions, slit lamp exams, and check for glaucoma, or visual field tests. You likely have metrics for what’s normal, and probably check the progress over time as they come in for annual checkups. 

The different parts of your finances can be assessed the same way, taking each part – cash flow, your balance sheet, insurance coverage, estate planning, investing – and evaluating the health and tracking progress. 

 So, how healthy is your cash flow?

How to Check the Health of Cash Flow

How you use your cash is what ultimately determines financial success. Cash flow is gas to an engine. Air to the lungs. Cash flow is to finance as gravity is to physics. It’s a law that’s universal. 

It allows you to buy the things you need and enjoy, invest for the future, invest in your business, be ready for opportunity, prepare for the unexpected, donate to those you love and to organizations you value, and just about everything else. 

Having clarity and control of your cash can lead to confidence and ease of mind. I’ve seen lack of clarity and control lead to stress and uncertainty.

So how do you keep control and awareness over cash flow? How do you track the health of your cash flow?

Cash comes into the house through your income. Associates may receive regular W2 salaries or 1099 income. Practice owners may receive owner distributions along with salaries, depending on the structure of the business. 

As the income comes in, there are only four ways you can use it:

• Taxes

• Spending/Giving

• Debt

• Saving/Investing

So how much of your cash is going to each category? Is that a healthy mix? How does that change over time?

I like to track what percentage of your income goes into each category. That leads to four metrics that are “vital signs” of cash flow health:

• Tax Rate

• Spend Rate

• Debt Rate / Debt-to-income ratio

• Savings Rate

I want to track whether they’re in healthy ranges and whether I need to take any action. Then, I want to watch as they change in the future. When I need to make decisions, like taking more debt or spending more, I can come back to those metrics.

So, what are “healthy” ranges for each?

The Vital Signs

The answers aren’t set in stone. They vary with age, household income, and other factors. But here are some guidelines to give you a feel for what’s appropriate:

Tax Rate 

Unfortunately, this is pretty subjective. It depends a lot on income, location, business ownership and structure, family composition, and so much more. Taxes tend to go up as income goes up, and that’s not necessarily a bad thing. You WANT your income to go up, and taxes are just a natural part of that. However, you also want to make sure you take advantage of the tax planning tools available each year.

Tax planning is a lifelong endeavor, and you want to focus on increasing income while limiting taxes over your whole lifetime (not just one single year). And keep an eye on effective tax rates (actual taxes paid divided by taxable income), not only marginal tax rates. 

Spending Rate 

The main driver here is household income. As income increases, you naturally see an increase in dollars spent. Lifestyle creep is a natural part of earning more. What’s important is that the percentage of your income you’re spending is staying consistent. 

In fact, as household income goes up and the actual dollars spent goes up, you should see your spending as a percentage of income decreasing. You would ideally need a lower percentage of your income to live off. Some healthy ranges to consider are:

While you want to keep spending reasonably, this can also be a big indicator of current life contentment. There’s a balance to be had in saving for tomorrow and spending for today. Enjoying life, going on vacations, buying fun stuff, and spending time with your friends and family. Life should be enjoyed, not only about saving for tomorrow. Do you have that balance in your life? 

Are you spending your cash in ways that are actually valuable to you and your family, based on your own values and priorities? 

Debt Rate 

How much cash flow is going to debt payments? There are times in your life when this increases and others when it comes down. Whether that’s healthy depends on your specific situation. 

Debt can be a consistent part of optometrists’ lives. Student debt, mortgages, practice debt, and commercial real estate debt. That’s not necessarily bad, but it should be managed prudently. 

Some drivers here are where you’re at in your career, your feelings around debt, savings rates, business plans, interest rates, length of debts, and other factors. Debt-to-income ratios on average fall between 20% – 30% of gross income. Below that would be relatively low, and above that would be relatively high.

Savings Rate

Your savings rate might be the best leading indicator of future wealth – how much of your income are you dedicating to saving/investing for the future?

There’s a whole industry working to sell you the idea that it’s all about buying their (expensive) insurance policies or investments, looking for high return with no risk (a myth), or taking courses to become an expert trader. 

But the reality is your future net worth will be determined mainly by your ability to increase your income, then turn that income into assets. 

You can see how important it is when projecting out the growth of your wealth. Let’s say you start investing in your 30’s. For at least the first 10 years, the majority of your account value is your own deposits. 

Compounding takes time. It’s not until later in your career the return on your investments really takes over. The amount you save, and how early you start saving, are so important to building your net worth. 

A healthy savings rate often (but not always) indicates a healthy range of other factors, and it should increase as your income increases. The main drivers are household income and career stage, but there are a lot of variables at play. 

A savings rate of 15% – 20% of gross income is a healthy target to start with.

Remember that it’s not only about retirement accounts. For example, what if you’re saving for a cold start practice purchase or real estate down payment? That’s a part of your savings rate and contributes to the growth of your net worth. 

Final Thoughts

What’s “healthy” for you for each of these metrics depends on your particular situation. Your family size, cost of living, career stage, business goals, feelings around debt, amount of net worth, age, and other factors all play into it. And remember, these are percentages of income, not dollars. 

It’s important to recognize that a change in one of the categories directly affects the others. Like most financial decisions, it’s all about tradeoffs. Your cash can only go four ways. If you put less into spending, it should be going to taxes, debt, or saving. 

Hopefully, these broad guidelines help you look at the health of your cash flow and at least help you start the conversation with yourself. These are vital signs, telling you whether you need to look deeper. 

 As you make decisions, you can come back to those metrics. For example, let’s say you were considering buying a new house with a larger mortgage. Your scores were:

• Tax Rate: 30%
• Spend Rate: 17%
• Debt Rate: 45%
• Savings Rate: 8%

Before diving into the details, we can make a few observations. Your debt rate is already much higher than our healthy range. This vital sign is telling us to look deeper. While your spending rate is very frugal, your savings rate is also very low. 

We can already get the sense that adding on additional debt payments may not make sense. Debt is eating too much of your cash flow, and you are likely not saving enough for future retirement goals. 

However, we might dive into the details and see opportunity. Perhaps you’ve been making high extra debt payments to student loans, or you have an opportunity to refinance another debt for a longer term and create more room in your cash flow. 

For them to be accurate, you do need a way to track where your money is going. This leads to the dreaded “b” word….budgeting…

It’s important to track where your dollars go. But I don’t necessarily think you need to hold a constant, by-the-penny budget. In fact, I’d advocate to be much stricter with cash flow in your practice than in your household, as long as your savings goals are met and debt isn’t increasing. 

I’m a big fan of “reverse” budgeting. That is, putting the first dollars you earn into saving and investing, getting to the savings rate you want. Then come your necessary expenses – debt payments, utilities, food, etc. Lastly, whatever is leftover after that, you have complete freedom to spend how you wish.

To track your numbers, you can use any method that works best – spreadsheets, Mint, Personal Capital, etc. All that matters is it works for you and is convenient enough to be consistent. 

For the ODs on Facebook community, I have a couple of resources you can put to use. You can click here to download a spreadsheet I made to track your cash flow. Or, click here to use the financial planning app I use directly with clients to track all of this.

I hope that’s helpful as we all work to improve the health of our cash flow!