024 | The 4 Cornerstones of Wealth Building: Cash Flow

00:06 – Patrick Lonergan (Host)
Welcome back to the Vital Strategies podcast, where we help entrepreneurs pay less tax, build more wealth and live a great life.

00:12
Today, we’re helping entrepreneurs shift their financial management from a disorganized, amateur structure to an expert level that every business owner can adopt. We’re going to introduce what we call the four cornerstones of wealth building that make up the entrepreneur private office. Those are cashflow, tax, investment and protection. Just like the cornerstones of a building, these categories are essential for constructing a robust financial foundation. They support and interact with each other to elevate your wealth from the ground up, maximizing stability to allow you tremendous growth throughout your entrepreneurial journey. My name is Patrick Lonergan and by the end of this session, you’ll have a full understanding of the framework of the Entrepreneur Private Office. We’re also going to do a deep dive into the first cornerstone cash flow.

00:59
The framework of the Entrepreneur Private Office was developed during my entrepreneurial journey through making mistakes and learning things the hard way. We have also had over 20 years of working with entrepreneurs and seeing what works and what doesn’t. We’ve worked with clients across the spectrum. We have seen growing entrepreneurs that are working their way up to a million dollars a year net income. We have worked with clients that have crossed over and sustained well over a million, three million and five million dollars a year of net income as well. There are also those clients that have cracked the code and they’re consistently making over a million dollars a month net income or 15 million dollars a year, just like me and my wife. Our clients are all self-made. They started from zero and built businesses from scratch. We have seen clients go through the trials of building a successful business and what it takes to maintain and continue to build wealth. We have also seen entrepreneurs that have developed tremendous wealth, making millions of dollars a year, not follow the framework of the entrepreneur private office and they suffer the consequences of losing it all or having to rebuild from a fraction of what they once had.

02:03
I’m excited to dive in with you and discuss the cornerstones of wealth building. Each cornerstone has different levels as your wealth grows. It’s possible you’re running a very successful business and have all of your cashflow pieces dialed in but are not even at level one in your tax strategy. That’s okay. We will help you progress through these different levels for each cornerstone so you’re positioned to accelerate your wealth building and shorten the time it takes to get to financial freedom. We help you into a position to protect everything you’ve built. If you’re just getting started, you can install these yourself. If you want help installing the Entrepreneur Private Office in your financial life, contact us at vitalstrategiescom forward slash client to have us help you make sure you’re paying less tax, building more wealth so you can live a great life.

02:46
Our journey begins with the first cornerstone cashflow. It’s the lifeblood of your finances. It’s about understanding the rhythm of your money, how it flows in and out of your business and your personal life. Cashflow is the most important of the cornerstones. If you don’t have positive cashflow in your business, there is no tax planning, there aren’t any investments and there’s no wealth to protect. Also, a fundamental of cashflow is having your bookkeeping in order. If you’re just getting started and you’re not disciplined enough to keep your books up to date on a monthly basis, you need to hire a bookkeeper. For a few hundred bucks a month or less, you can have accurate data that gives you a clear understanding of your financial life. Understanding your profit and loss statement and your balance sheet is like having constant insight into your body’s blood work, to know that you are healthy and there aren’t any signs of trouble.

03:33
If we aren’t looking at the financials. Things might look good on the outside, but the financials can tell a completely different story. So level one of Cash Flow Cornerstone is know your annual free cash flow. First, calculate your annual free cash flow. Here is the formula Net income from your business. This includes your wage and your distribution. Subtract your living expenses and tax payments, this is your annual free cash flow. This figure is your financial pulse, showing the health of your business. After all, the obligations are met. Is this number positive? If so, by how much? If it’s negative, there’s a problem and you need to adjust.

04:12
We generally see entrepreneurs that are making a million dollars a year have their cash flow break down as $30,000 a month to living expenses, $30,000 a month to taxes and $30,000 a month to investing. An interesting point that we see is that entrepreneurs that start making $2 million a year, they still only spend about $30,000 a month on lifestyle. They’ve sort of figured it out that, making more money, I don’t necessarily need to spend more to be happy that $30,000 seems to take care of all of the lifestyle that they want to enjoy. Then they’re paying about $60,000 a month in tax and saving about $90,000 a month. Knowing your free cash flow will help you build a tax and investment strategy to accelerate your wealth.

04:52
Now level two of cash flow is develop a cash flow calendar and map. Developing a cash flow calendar map just isn’t bookkeeping, it’s strategic planning. Forecast out your cash flow so that you know that you can afford everything from the real estate, investment, home remodel and tax strategy that you want to invest in. Determine your minimum necessary liquidity. A part of the cash flow calendar is knowing what your minimum and maximum liquidity thresholds are. As a rule of thumb, we use 12 months of living expenses for liquidity for both personal and business purposes, and a maximum threshold of 24 months of living expenses.

05:30
Too little cash is the number one reason businesses go out of business. Too much cash is inefficient. We can put those dollars to work over and above what you need for the maximum threshold. Now, if you have a large payroll number, you may wanna keep three or four payroll cycles on hand for a minimum threshold. Having a large margin of safety is one of the best wealth building tools available to you. It protects the main growth engine, the business. It allows you to survive through tough times. Also, after you survive, you can pick up assets for pennies on the dollars when your competitors didn’t make it. If you don’t have your minimums, you build up to that minimum through disciplined, automated savings. Proper liquidity is much like setting a foundation before building a house.

06:11
Next is the cash flow map, which just creates a flow chart for all of the income that is coming from your different entities and in what format. We create a distinction between active and passive income on your cash flow map because they have different tax treatments and both need a plan. Okay, moving on to level three of the cash flow cornerstone automating investments. Automation is important and underutilized. We open a cash management account for all of our clients to hold excess liquidity, to be able to earn additional interest but still have access to move money into client’s operating account if needed for operations. If liquidity is lower than the minimum we established in the cash flow calendar exercise in level two, we need to automate dollars into this account until we hit that minimum number. Once you exceed your minimum liquidity, we can start using the cash flow calendar to decide on the automated transfers into an investment brokerage account. We’re going to pick a number that allows you to maintain your minimum liquidity with all of the personal and business moves you have going on this year.

07:12
Imagine installing a smart home system in your financial house. This system isn’t just fancy technology. It’s essential for maintaining the efficiency and functionality of your finances. Automating your cash flow, savings and investments is like setting up automated systems in a smart home it’s efficient, it’s consistent and it compounds over time, turning your ongoing contributions into a much larger sum down the road. A common example of this is the payroll deductions for a 401k. It’s why millions of Americans have enough money to retire, even though they may not have had the financial discipline to save. It’s worth it. Set up automated investments every single month so you don’t have to think about it Moving on to level four of cash flow cornerstone optimize borrowing. Let’s talk about the cornerstone of wealth building optimizing your borrowing.

07:59
Envision your debts as the load-bearing walls within the structure of your financial strategy. Just like the physical walls that support a building, these financial obligations hold up your economic well-being. To fortify your financial house against a risk and enhance its longevity, you need to address these debts strategically Structural reinforcement through refinancing If a wall is weakening under too much pressure, you reinforce it with stronger materials. Similarly, refinancing high-interest debts can significantly reduce the pressure, the interest burden they exert on your financial structure, strengthening your economic base. Streamlining with debt consolidation Combine multiple weaker beams, smaller debts, into one strong beam, a single consolidated loan. This not only simplifies the framework of your debts, but also makes them easier to manage and less costly in terms of interest. Much like streamlined, more efficient load-bearing structures. Next we have strategic load distribution with debt prioritization. Just as an architect assesses which parts of a building to fortify first based on stress levels, strategically prioritizing debt repayment, especially the high interest ones, ensures that the most financially pressing walls are addressed first, thereby maintaining the integrity of your overall financial structure.

09:15
Now we’ve talked about paying off the high interest loans first. We’ve also looked at Dave Ramsey’s strategy for the debt snowball, where you address the smallest debts first. We really like the psychology around paying off the smallest debts first and then working to the next smallest debt and all the way up. The financial answer is paying off the highest interest debts first. It just makes the most financial sense. So if you automate those payments, you can just pay those debts down as quickly as possible. That way. We think that’s the better way to go. But the psychology says to pay off the smaller debts first, get those small wins and go from there.

09:50
Now, finally, let’s talk through paying down loans quickly and what it means to have debt equity. When I pay down a loan faster than the scheduled payment, it is saving me money by reducing the long-term interest. The issue is in the short term, it does nothing to reduce the monthly payment, and if I need that money for anything, it’s debt equity inside of my balance sheet. The only way to get it is to sell the asset or refinance. We want to make sure that our liquidity position is solid in the cash flow calendar that we discussed above, before we start paying down debt at an accelerated pace. Oftentimes, what we like to do is build liquidity to the point where we can wipe out the entire debt all in one time.

10:30
Next, we’re going to take a brief overview of the three cornerstones that we’ll cover in future episodes. So, to wrap up the cashflow cornerstone, the first level is understanding your annual free cashflow. Level two is building your cashflow calendar and map critical tools for your cashflow planning. Level three is automate your investing, and level four is optimizing your debt. Now we’re going to talk about the second cornerstone, which is tax savings. Every dollar saved here is a dollar that we can be reinvesting in our business or investments. We’ve covered the four levels of tax planning in depth in previous episodes, so feel free to go back and listen to those as a recap.

11:12
Here are the four levels of tax planning. Level one the IRS gives us guidance, but it doesn’t take any investment. This is really just good administration and bookkeeping. Level two the IRS gives us guidance, but we have to make a financial investment, think 401k and IRA. Level three we’re combining sections of the tax code to create tax efficiency. Now, these sections of the code can be abused if not done properly. We almost always have a third party administrator involved and we make sure every I is dotted and T is crossed. Level four is tax fraud, and the reason we bring this up is there’s people out there pitching strategies that will get you put into tax jail. You don’t want to be with Wesley Snipes in tax jail, I promise, so we bring it up because it’s something that needs to be addressed.

11:56
The third cornerstone is investment strategy. This is where you start to build towards financial freedom. Again, we wanna make sure that our cashflow and tax strategies are solid before we start building in an investment portfolio. Level one of the investment cornerstone is build portfolio wealth. We like to aim to build portfolio wealth that equals at least one year of income. This allows you to have additional liquidity if you need it or if there are tremendous opportunities in the marketplace, you can access this capital to buy distressed assets. We think portfolio assets equal to one year of income is a good place to start, before you start investing in illiquid investments. Level two real estate investments. We think you should diversify into real estate investments. They’re one of the best wealth building tools on the planet. They have four main categories that allow you to accelerate your wealth building Appreciation, amortization, cash flow and tax benefits. I’m personally involved in over $150 million of real estate deals.

12:57
Level three is achieving financial freedom. This is the ultimate destination financial freedom. This is the point where your assets generate enough income to cover your lifestyle indefinitely. We want to shorten the timeframe to financial freedom as quickly as possible. Then, once we get to level three, we have the opportunity to consider level four investments. These are high risk, high reward opportunities.

13:20
Once you secure financial freedom, you might consider moving four investments. These are high risk, high reward opportunities. Once you secure financial freedom, you might consider moving into investments such as private equity. These values can go to the moon. They can also go to zero. Unfortunately, we’ve seen clients that have come to us that have had millions of dollars in private equity opportunities and they didn’t have access to the capital. They lost tremendous amounts of value and it was really a problem. Their financial freedom was not secure and it just became more unstable with these investments. We don’t think they’re bad, we just think they have their place. We think it can slow down the process to financial freedom.

13:55
So to wrap up, the third cornerstone of investments first, build portfolio wealth equal to one year worth of income. Two, invest in real estate opportunities, tremendous wealth building tool. Level three secure your financial freedom. And level four take moonshot opportunities with private equity and private investments.

14:14
Now the fourth cornerstone of the entrepreneur private office is protection, fortifying your financial fort. Now our final focus is on protection defending the wealth you built from unforeseen threats. The first level of the fourth cornerstone of protection is insurance. Utilize insurance policies to shield against catastrophic losses. Life, disability, property, casualty are just your first layer of defense. Level two are legal structures. Employ government protections like the homestead exemption and the exemption for retirement accounts to shield and protect your assets. Now, these vary from state to state, but they can be valuable tools to protect your assets.

14:55
Level three is entity structure. Consider the formation of entities like an LLC to provide additional layers of protection. These are your castle walls that separate your assets from creditors. Level 4, utilize favorable jurisdictions to further safeguard your assets, placing your wealth in strongholds with the most protective laws. Level 5, trust structures. Implement trust structures to manage and distribute your wealth securely. Trust are the secret passage and hidden chambers that keep your treasurer safe. And there you have it a full building plan that will allow you to implement the entrepreneur private office. These strategies will not only save you from financial peril, but also lay the foundation to build a tremendous amount of wealth. Thank you for tuning into the Vital Strategies podcast. Visit us at vitalstrategiescom forward slash cashflow for detailed guides and tools to help you implement the first cornerstone of cashflow. Again, check out vitalstrategiescom forward slash cashflow for tools to help you execute on the four levels of cashflow planning we discussed today. I look forward to next time when we discuss more strategies to help you pay less tax, build more wealth and live a great life.