Why Does a Credit Card Balance Increase My Cash Flow?
Running an ever-increasing credit card balance appears to increase your cash flow, but it is merely a short- term illusion. In the long run the additional interest expenses will decrease your cash flow.
Other People Are Reading
-
Cash Flow
-
Cash flow is the difference between the amount of money that comes in during the month and the amount that goes out during that month. Cash flow is positive if more came in than went out and negative if more went out than came in. A positive cash flow is preferable to a negative cash flow.
Paying Off The Credit Card Balance Every Month
-
If you pay off your entire credit card balance every month you are not "running a balance," and it has no net effect on your cash flow. This is because rather than paying the merchant you are simply paying the credit card company the same amount. So in this case, it is easy to see whether your expenditures are greater than your income.
-
Running a Balance
-
If you run a balance on your credit card, however, a strange thing happens. At first it appears that your cash flow increases. This is easiest to see with a simple example. Assume that your income is $3,000 per month and your expenses are also $3,000 per month. Your cash flow is neither positive nor negative. But then you get a new credit card and instead of paying cash for your groceries, rent, and gasoline you put them all on the credit card. At the end of the month you have spent $1,000 cash and have a balance on your credit card of $2,000. At this point it appears that you have $2,000 cash left over at the end of the month. So your cash flow increased, but now you also have a $2,000 debt hanging over your head.
The Problem
-
The problem comes two months later when your credit card comes due (if you had paid it in full after one month there would have been no interest). At this point, since it is a new month, you still have your $3,000 income and your $3,000 expenses, you have $2,000 in the bank (unless you spent it because you thought you had money left over) and you owe the credit card company $2,000. But this month you also owe the credit card company interest on the $2,000 the company loaned you. If your annual percentage rate is 24 percent, or 2 percent a month, this would be about $40 per month (or $80 total). So this month if you took the $2,000 out of the bank and paid off the credit card and went back to paying your $3,000 of regular expenses in cash, you would still owe the credit card company the $80 interest. In other words you would have a negative cash flow. You owe more than you earned. So even though it appears that running a balance on a credit card improves your cash flow it actually hurts you in the long run for two reasons. The first reason is that it hides the true nature of your expenses and secondly, you owe more money than if you hadn't borrowed in the first place. To see the effect of paying less than the full balance every month see the Squawk Fox credit card calculator (see Resources 1).
-
References
Resources
- Photo Credit credit card and hand image by Warren Millar from Fotolia.com
