Cash Flow, ROI, and Cash on Cash
This post is part of a series of basic educational posts. Most of this blog is about higher level business and investment activity. However, in order to understand those posts, you need to make sure you understand the language. Most of you will probably already know what I’m talking about but we need to make sure everyone gets caught up.
In the investment world, you will often hear the terms ROI or cash on cash. ROI stands for return on investment and cash on cash means the same thing. The concept is pretty simple but very powerful and, frankly, dictates pretty much everything I do as an investor, as an owner of real estate, or as a potential buyer of a given business.
ROI and cash on cash are defined by the percentage of your investment returned to you over the course of a year. For example, say in order to purchase a $100,000 home, you put down $20,000 and got a mortgage from the bank to cover the rest. The money that you make from that house rental will be equal to the rent minus the expenses including the mortgage payment you have to make as the owner. Let’s say that after paying the mortgage and the expenses with the rent that you collected, you still ended up with $400 profit at the end of the month. This profit is also called your CASH FLOW for the month.
If each month averaged the same over 12 months, your total cash flow for the year would be $400X12 or a total of $4800. Your ROI or Cash Flow is equal to your 12 month cash flow divided by your initial investment which was $20,000.
So, yearly cash flow/initial investment—————-$4,800/$20,000=0.24 or 24 percent. This investment you made would have an ROI or cash on cash of 24 percent!!! You have made a great investment!
Investments should ALWAYS have positive cash flow. That may seem obvious, but people often make investments that are not positive for various reasons that we will get into later. The ROI or cash on cash and investor expects from a given investment will be different depending on the relative stability of that investment. We will get into these kinds of things a great deal in other advanced topics in this blog.
However, for now, you should understand what people mean with they say cash flow, return on investment (ROI) and cash on cash.