Revisiting the Two Levers Philosophy of Cash Flow Management

One of the major lessons I’ve tried to teach is that building your net worth comes down to two levers: Cash in and cash out.  That’s it.  That is the entirety of the game when you peer past the distractions and gaze into the heart of the mathematical reality.  From a financial perspective, every action you take for your career or business ultimately only matters in so much as it someday serves to exert force on one of those levers so that more cash is flowing in than is flowing out, leaving a surplus.

It sounds so simple but when you see things through the focus of this particular lens, you can more quickly identify the actions that are likely to have an outsized effect, both for good or bad, on net worth.  (Even in areas that might not seem evident at first.  Case in point: Lehman Brothers wouldn’t have gone bankrupt if management had thought this way because the idea that they were always a phone call, or downgrade trigger, away from having to come up with significant cash resources relative to book value would have caused them to reorder the entire firm or else they’d have been unable to sleep at night.)

A common mistake I see when people attempt to honor this principle is a tendency to focus on sticker rates and/or first-order effects.  They look solely at the immediate income or immediate outflow of a decision, ignoring other relevant cash flows that might result down the line which should be appropriately discounted.  These include:

  • Life Cycle Costs: Five or six times in the past few years, we have discussed the work of the late Dr. Thomas J. Stanley, particularly his research that ultimately formed the basis for the publication of a tome called The Millionaire Mind.  Self-made millionaires in the United States have a habit at looking at the total life cycle costs of a decision rather than the upfront outlay.  This is one of the reasons that, dollar-for-dollar of income, engineers tend to end up with significantly higher net worths than the predictive models alone would indicate; from appliances to cars, shoes to computers, their personality causes them to disproportionately kick the proverbial tires, read reviews, and factor in things like maintenance costs, repair coverage, and gas mileage so they emerge with a much better picture of the long-term consequences of an outlay.  Stanley used the example of shoes, finding that people who tended to amass money were more likely to do things like spend $300 or $400 on a good pair of Allen Edmonds, then have them rebuilt for a fraction of the cost throughout their lifetime.  Despite the higher upfront outlay, it resulted in fewer overall outlays as the cost-per-wear was decimated.
  • Opportunity Costs: Making an outlay today to increase your income cash or decrease your outgoing cash must include an analysis for the opportunity cost of what that cash could have done.  This is true in time as well as money.  (One of the lessons my grandfather, who owned a demolition company in San Francisco, used to teach my dad was, “Never contract for a low-paying job just to stay busy.  It will take up your time and make you unavailable to act when the really lucrative opportunity comes down the pike.  Sometimes, to make real money you have to know when to turn down cash flow today.”  There are echoes of this philosophy in Abraham Lincoln’s quip that if you tasked him with cutting down a tree in six hours, he’d use the first five to sharpen the ax.)

Sometimes, taking an action that looks like it will increase your cash-in will actually result in more cash flowing out down the road.  The collapse of Wachovia comes to mind.  So, too, does a story from my own life.

Years ago, an acquaintance of mine had a friend fall on her property during a regular visit.  This friend-of-my-acquaintance broke her leg entirely due to their own negligence.  One day, the acquaintance discovers she’s being sued for medical bills.  Her homeowner insurance policy decided to settle since it was quicker and easier than a protracted legal battle.

Imagine my acquaintance’s surprise when the (now former but apparently not getting the memo) friend – who hadn’t made any contact at all – showed up for their regular visit as if nothing had happened.  The friend was both bewildered and in disbelief that they were turned away at the door and told future contact was not welcome.  “Why are you so upset?!”  they wanted to know.  “It was just a homeowner settlement.  I wasn’t suing you, I was suing the insurance company to pay my bills.”  (Conveniently ignoring, of course, the deductible as well as the now-higher homeowner insurance premiums that will result in tens of thousands of dollars in costs to my acquaintance over time.)

The friend became persona non grata in the community.  It was as if she truly never stopped to consider the consequences of her action; to ask herself:

  • What sane person would invite her into their home?
  • What rational man or woman would have their children over for a play date or allow their own kids to drive her kids around after school?
  • What sensible employer would bring her onto the payroll knowing this was the way her brain worked?

Her total inability to understand basic incentive systems, reciprocity, networks of trust, and, as Munger might say, basic Kantian fairness, caused her to foolishly grab a little bit of money at an ultimate cost that was exponentially higher, if not difficult to precisely measure.

(A similar story was in the news yesterday when a Connecticut jury ruled against Jennifer Connell, the woman who sued her now-12-year-old nephew – a nephew whose mother, Lisa, died last year – for $127,000 after she broke her wrist when he jumped into her arms excitedly, professing his love for her, at his 8th birthday party.  Connell reportedly said her injuries included such harrowing experiences as: “I was at a party recently, and it was difficult to hold my hors d’oeuvre plate,”  Though she walks away a loser – poorer, in fact, due to her legal and time costs – even a full victory would have been dwarfed by the ultimate expenses and closed doors incurred due to committing what amounts to total and complete social suicide.  The stupidity and immorality of the lawsuit, even if she needed the insurance money and was facing bankruptcy (there’s no indication she does or was but perhaps you’re inclined to charitably look for some potential justification where none exists), was so beyond comprehension, so outside the bounds of acceptable human behavior, that one writer didn’t believe it could be real, only accepting it after finding the case files – see FBT-CV13-6033608-S, CONNELL, JENNIFER v. TARALA, SEAN.  Her face, her home address … it’s all over the Internet now.  She will never outlive this.  As long as she draws breath, this will haunt her.  There is something deep in the human psyche of most ordinary, decent people that wants to see her destroyed.  It’s visceral.  She violated an unspoken rule woven so intrinsically into individuals at the genetic level that some commentators have argued only a sociopath wouldn’t understand.  I’ve even seen arguments that her lawyers should be disbarred for accepting the case.)

This is the secret to the profitability of Berkshire Hathaway’s insurance subsidiaries.  Present management knows this.  It’s in the culture.  While many other (not all) insurers are out there competing on market share, seduced by the big upfront cash flow that comes from writing a new policy, it will turn down a contract if it thinks the resulting outflows are insufficient to justify taking it onto the books.  It’s the only sensible way to conduct business.  You can go broke reaching for the cash.

On the Flip Side: Make Sure the Second and Third Order Effects Pay Off If You Do a Lot of Work for Nothing

Equally as important, you need to make sure you don’t give away your work product for free all the time for some vague notion of “publicity”, banking on payouts that come down the road but, somehow, never materialize.  Sure, that can be an intelligent thing to do under the right circumstances – if it really is going to get you in front of a huge audience that can change your life in a heartbeat, driving sales of your products or services.  If it won’t, you need to be like Dolly Parton; sweet, supportive and kind but fully aware of your value.  If you don’t send her a check for her intellectual rights, she’s going to hunt you down, tie you to a fence, and horsewhip you until you cough up the coins you owe her.  There’s a sense of basic fairness involved.  Each person gets something from the exchange and is expected to honor it.  No one is entitled to your work.  You are not required to sacrifice yourself on some altar of martyrdom for the sake of your art.  I see people do this all the time in music, literature, and technology, especially.  I don’t understand it.  They give away their best efforts for nothing, as if it were trash; accepting a pittance while allowing someone else to sell it for millions (in a few cases, billions).

Legendary science fiction writer Harlan Ellison once delivered a diatribe on the topic.  It’s called “Pay the Writer”.  (Warning: Language is NSFW.)

The point of all of this is to remind some of you that you need to look at the entire cash flow timeline and factor in all consequences that can be known about a decision when determining whether pulling a specific lever, at a specific time, is worth it.  Some actions may appear to bring no immediate benefit but make you richer down the road.  Others may look like they are profitable at the moment but send you straight to bankruptcy court (something corporate executives seem intent on re-learning every decade or so as they accept insane risks for a bit of extra revenue).  Focus on the bigger picture and then make a decision.  Intelligently implemented, it should improve the long-term economic results of your life materially.

  • Todd

    We had our 401k meeting this week. They are also closing out our defined Pension Plan. Most people talk they are taking there money out and not going to invest it in the stock market (401k) because the so called Market Risk. A lot of people come to me ask me what I think. I tell them there is no such thing as Market Risk overtime, but there is what I call Behavior Risk. I tell them the stock market is a Department Store , if they mark down prices 10,20,50% you should be happy. I tell them what would you do if you where in Target, Walmart , Dillards and Von Maur and they had those kind of sells would you leave the store or buy. And what about people that are drawing on retirement money that is invested in the market All I can say is sales don’t last.

  • Ang

    Just another example of how interwoven and connected certain disciplines are to life itself. Probability and odds, permutations and combinations, the understanding of this leads to better long term decision making in life, business, and in investing. It strikes me that learning the insurance business could really help a lot of investors (and really learning it, over the full cycle of writing contracts and making payouts on all sorts of different scenarios with different probabilities and odds, so they can truly learn what “risk adjusted” stands for and not just rely on beta), but then for a not so insignificant portion of investors, it might just drive them to take on more wipe out risk in exchange for that cash upfront. Some people are just gamblers, I guess

  • Elton

    Like it!
    In a way this is also very similar as to evaluating what career decisions to take. Will you take the job that offers lower pay but much bigger career opportunity, or will you go after the job with the money where you might get stuck with little career development. Each works for ones life situation, but at the end of the it comes down to deciding what you value more.
    For the lady suing her nephew, she didn’t care about the community or family, but was after money as that was what was clearly more important to her.

  • Joshua Myers

    A very good reminder. Having spent some hyper frugal years (driving a $500 motorcycle to work in the winter type frugal), it’s been hard for me to transition to a life cycle cost mind set. Now I’m on the hunt for major life upgrades that are cost neutral over a certain period of time. I did this with the Staub cookware this past Christmas. Now I’m looking into LASIK eye surgery, which should be cost neutral in 5-10 years given how much I pay for glasses and eye insurance. If I can improve my life dramatically by spending the same amount of cash then it should be a no brainier.

    If anybody out there has any other ideas that fall into this category please share. Doesn’t matter how big or small. I’d love to hear them and I’m sure that a bunch of other people on reading this feel the same.

  • Reminds me of the dilemma investors can sometimes face when it comes to dividends: take the high-yield, low growth a la PMI or RDS and plow that higher cash flow into more “attractive” opportunities or take the low-yield, high growth a la DIS or SBUX and plow the lower cash flow back into more shares of the respective companies.

    We once did the math and there is no right or wrong – depends entirely on what your goals are and where that cash flow goes.

  • Ang

    Probably not the exact type of thing you are looking for, but I think a giant investment everyone could make in terms of time is setting up a good diet and exercise regime (AND, importantly, structuring it in a way so that you know you will actually follow it/carry it out). One of those things where the rewards can be seemingly invisible at times, but as they all say, the best way to become rich is to live longer

    It’s funny, the best things you can do with your life are often always so straight forward, but always gets lost in the noise and distractions of daily life for a lot of people

    • On personal fitness/exercise I could not agree more. Over a lifetime, it will have compounding effect that will shower you with health dividends that are probably even more important than monetary dividends.

    • Joshua Myers

      I agree 100% Ang. Health, fitness, and well being are probably the best investment that a person can make. 20 minutes of meditation, 30 minutes of exercise, and healthy eating will probably add more productivity to your life than anything else that you can do.

    • Gilvus

      Sheepishly puts down the triple bypass burger

  • peter gryphon

    “Never contract for a low-paying job just to stay busy”. Great point. My company just encountered this bidding on a federal contract and was low-balled by a certain government office on the price. Luckily we didn’t take it, and good-riddance to that particular headache, which would have turned into a money-pit. The company that was awarded the contract has never turned a profit on it in the 10 years they’ve performed the work, but are a part of a much larger firm that wants to keep a foot in the door with this particular federal department.

  • I have seen similar behavior that was out of bounds as well. It often involves roping the legal system in. At least in law school, they try to dissuade you from that by teaching you in Civil Procedure about how bad for you it is to file suit.

  • Jeff

    I’d check out the complication rate for LASIK very carefully. Personally I don’t think the risk is worth it for me.

  • Preston Nelson

    Corneal molding. Same benefits as lasik, risk in line with contacts…

    • Joshua Myers

      I’ll check it out. Thanks for the recommendation.

    • lrdey

      Depending on your prescription, LASIK or other forms of refractive correction (orthokeratology or otherwise) may not be the most suitable for you. Better off speaking with an ophthalmologist or OD about it, as various information on the net can be a bit misleading.

  • Mark

    My wife and i unfortunately encountered the same type of senario as that poor child.
    Our two children, both diagnosed with autism, were under the care of our two in-home workers when they decided to go to the local park. Our son was critically injured when he was struck by a car while running back to the worker’s vehicle.
    He suffered many injuries such as a shattered femur, closed head injuries, dozens of lacerations,etc. He stayed in a comma for more than a month and was in hospital for almost two months. The priest was called on two separated occasions during this time as the medical staff did not think he could overcome his injuries.
    Two years later (less one day) we were served papers stating that we were being sued over the accident.
    When we obtained a lawyer we were told that the couple who occupied the vehicle that hit our son waited to file the lawsuit so that we could not counter-sue for certain damages because of a statute of limitations of two years.
    Myself, my wife,my son (8yrs old at the time), both workers, our township and a branch of the government that assists with funding for the workers, were all served documents stating that they were being sued over the incident.
    During discoveries, prior to trial they settled for an undisclosed amount of money (I am not aware of the amount) that was contributed by the parties being sued. Apparently the amount was cheaper than the costs of going to trial.
    It sickens me that this type of lawsuit can even exist. I realize that the occupants of the vehicle went through a tramatic experience as I would not wish that upon anyone, however financial gain over a very unfortunate accident is hardly appropriate. My thoughts and prayers go out to Sean Tarala

  • JB

    Great post, thanks for taking the time to expand upon the Jennifer Connell lawsuit. Thanks also for posting the interview with Harlan Ellison; thats a classic!

  • Nirav Desai

    haha, that’s a great video!

    Hopefully, it will make me forget I want a pair of $500 Jefferson wingtips that I didn’t need 15 minutes ago.

  • Gilvus

    Joshua, if you go with glasses from Lenscrafters or your optometrist’s office, you’re probably getting gouged by Luxottica SpA for two pieces of plastic glued to a piece of metal wire. I went to Lenscrafters, took pictures of the frame I liked ($400 from some dude with a catchy foreign-sounding name), and went on a website to pick frames that were pretty much identical. My left eye is hilariously misshapen and requires 2x the diopters compared to my right eye, so I opted for the high-refractive index, fancy-pants lenses so it wouldn’t look like I’m wearing bulletproof glass on my face. Then I went with the anti-fogging/water resistant and anti-reflective coatings, because why not. I only paid $70 for the whole package, and as an added bonus the ladies can’t get enough of me!

    Okay, I lied about that last part. But everything up to and including the $70 cost for a pimped-out pair of glasses is true. This was 2.5 years ago, and I’m currently wearing the same pair of glasses as I type this, and have no complaints about the workmanship. This was after I bought a pair of birth-control-for-my-face glasses for $250 when I was still in school. I highly recommend looking into reducing your eyewear costs before letting them shoot ultraviolet lasers at your eyeballs.

  • PastIsPrologue

    Nice summary. I knew about the life cycle costs on things but hadn’t thought about it for chairs and shoes. So I went back over the last five years of shoe purchases. And like clockwork every year I would spend $200 on two pairs of shoes (good, but not repairable) for work when the soles wore down to nothing. That is $1000. For five years. And while I was at Allen Edmonds yesterday obtaining what is both clearly higher quality and not-so-obvious-at-first lower costs the sales rep mentioned he had someone bring in sixteen year old shoes earlier to repair. Think of that from an environmental perspective – in that same time I have spent $3000 and sent 32 shoes to landfills since most couldn’t even be donated. Thanks for pointing this out – I can’t believe I didn’t catch this until now. Tomorrow morning I will be walking in Edmonds…


    I got paid 104000 bucks in last twelve months by working from my house a­n­d I manage to accomplish that by w­o­r­k­i­n­g in my own time for 3+ hours daily. I followed a money making opportunity I found online and I am so excited that i earned such great money. It’s so user friendly a­­n­­d I’m so grateful that i discovered this. Here’s what I did… SECURE37.COM