Cash Flow = Income – Expenses (Seeing Money as a River)
Money flows into our life via our income and flows out of our life via our expenses. Cash Flow is the amount of extra money we can put to use any way we like after subtracting our expenses from our income; it is an important indicator of our financial health.
Our Wealth = Our Money / Our Expenses
Wealth is measured by how long we can continue to live our current lifestyle if we stop working. If we have $10,000 and spend $1,000 per month, then our wealth is 10 months.
True Wealth = Unending Cash Flow
The truly wealthy are able to extend their wealth indefinitely. This means that they have attained Financial Escape Velocity and need not work anymore.
Understanding True Assets & Liabilities
Many people make the mistake of many people of acquiring liabilities while thinking that they are assets. True Assets feed us by generating income. Examples include:
- Licensed Intellectual Property
- Rental Real Estate
- Interest-Bearing Loans
True Liabilities feed on us by generating expenses. They include:
- Personal Car (petrol, maintenance etc)
- Personal Home (land tax, utilities etc)
- Personal TV set (electric bill, maintenance etc)
Active vs. Passive Income
Active income requires much constant effort from us. Examples include working in a job, small business and speculating in shares. Passive income may require much initial effort, but little constant effort. Examples include establishing a business franchise, writing a best-selling book, renting out real estate property to a long term tenant and making a long term interest-bearing loan. Passive Income is the “secret” of attaining financial freedom.
However, it is rare to have a truly passive income. Best-selling books will eventually lose popularity, real-estate properties will require supervision and maintenance, business franchises require managing franchisees, while debtors may refuse or be unable to pay back the loans. Do not become so fixated on this concept that we refuse to earn active income.
Since money has to come from somewhere, passive income comes from using other people’s effort and money to enrich ourselves. However, in order to leverage on other people, you must offer them something in return that they want.
Capital Appreciation vs. Cash Flow
Capital appreciation occurs when something you own can be sold in the market at a higher price than you purchased it. For instance, a house that you purchased a few years ago can now be sold for double the price that you previously paid. When we seek to attain financial freedom, cash flow is what we are really looking for. Even though a house can wait 10 years to appreciate in value, but our stomach cannot wait that long.
Money loses value because the governments around the world are printing more and more of it to try to pay off their national debts. When people lose faith in the value of money and try to convert it immediately into other things, prices will rise rapidly until money loses most of its value or becomes completely worthless – this is called hyperinflation.