There are countless tips on the internet on how to get rich overnight, and this is not one of them. This is probably a slow way to wealth, but one that is reliable, predictable, and best of all, customised to your specific financial situation.
In one word, the way to increase your cashflow and wealth is…
MEASURE (your cashflow and wealth)
What gets measured, improves. Stare daily at the spreadsheet that I’m about to show you how to do, and the power of this focus will eventually show you the way to make the numbers go the way you want them to.
What we are going to do here is establish exactly what your financial situation is. It will then become clear what you need to do to have the lifestyle that you dream of.
This is a relatively long post, and if you are going to actually do the spreadsheet along with me, you’ll need at least 30 minutes of uninterrupted time. It’s well worth it though, if your investment of 30 minutes can start you on the path to accumulating wealth and generating enough positive cashflow that you never need to worry about paying the bills again, and have enough to enjoy life on top of that.
Your personal financial statement
There are four aspects of your finances that you need to get control over, or at least be aware of, if you want to see your overall finances improve. These are your: income, expenses, assets, and liabilities.
Start by taking a blank sheet of paper or opening a new Excel worksheet. Divide the page into 4 sections.
List down all your sources of income, being careful to differentiate between two main types of income: active and passive.
Active income is money that comes to you only when you have to perform some sort of action, like go to work.
Passive income will come to you without you have to do anything, like rental from a property that you have rented out.
For annual payments like dividends, simply divide by 12 and put the average monthly figure in. If your income fluctuates from month to month, again use the monthly average. Just put whatever you earned this month down now, then when next month’s paycheck comes in, add that to this month’s figure and divide by 2, then add the third month and divide by 3 and so on.
The savings rate is the amount you pay yourself first every single time you receive a paycheck. Write down whatever your rate is today, even if it’s a negative figure. Be truthful since no one will see this sheet but yourself, and it is essential to know your exact financial status before you can see it improve.
A good savings rate to aim for is 50%, which means that you spend half your earnings on the present and half on your future. Start with 5% or even 1%, but this number MUST be greater than zero if you want to increase your wealth.
On a personal note, I’ve tried saving both at 5% and 50% and found that either way, whatever was left was never enough. So I figured that since it hurt equally badly, I’d rather hurt with 50% in the bank than 5%. If you get this point, you can go for a 50% rate right away and see your wealth grow at a tremendous pace.
Total passive income
You’ll notice that I don’t bother with total active income, since for me the only reason to have an active income is to be able to save part of it, hence it is the savings rate that matters. Of course, the active income pays the bills too, though that should not be what you choose to focus on.
Your total passive income figure tells you how much you will have coming in every month if you cannot or will not work anymore. Your financial freedom depends a great deal on this figure, as will become clearer soon.
Record the main categories of expenses that apply to you. The easiest way to do this is to key in the amount on every bill that you receive before filing or disposing of the bill. Don’t foget your car-related expenses if you have a car. Again, use monthly averages if the amount varies from month to month.
Daily living expenses
Instead of tracking every latte that you drink, as some budgeting gurus teach us to do, I simply put ‘Daily living’ as one big category without any details. You just have to decide on a total figure for daily living expenses. Ideally your daily living expenses should be however much is left from your active income after subtracting your savings first, then bills next. Since your bills vary from month to month, it’s a good idea to leave at least a 10% buffer for bills so you’re never short.
Another personal note: To make sure I keep my daily living expenses in check, I withdraw a quarter of my monthly discretionary income every Sunday, and allow myself to spend cash only. This takes a lot of guesswork out of budgeting and ensures that you keep to your financial plan.
You want to keep a very close eye on your Total Expenses figure. Keep this figure as low as possible. For now, keep it where it is without increasing any further, until you have your finances under control and know exactly where every increase in expenses is going to come from (ie from the income or asset column).
One additional figure I track is what I call my retirement ratio, which is simply your total passive income as a percentage of your total expenses. In the example above, you would be 30% to achieving retirement.
Your goal, of course, is to achieve 100%. At this point, your passive income is enough to pay for all your expenses, and you don’t need to work anymore unless you want to. To get to 100%, you have to either reduce your expenses or increase your passive income. The latter is more fun, and requires an intimate knowledge of your assets and liabilities.
Your assets and liabilities
While most accountants would tell you that the house you live in and your car are assets, I prefer to use Robert Kiyosaki’s definition which is much more useful when you are trying to get control over your cashflow.
An asset puts money in your pocket; a liability takes money out of your pocket.
– Robert Kiyosaki
Your residential property – asset or liability?
I don’t include the place I live in now in my asset column since it doesn’t put money in my pocket but takes money out in the form of utilities and phone bills. I also assume that if I sell the place, I’ll have to use the equity gained to buy another place to live in, so it’s not really an asset that’s convertible to cash anyway.
In any case, the definition of a millionaire is your net worth excluding the property you live in. So if you want to track how close you are to being a millionaire, it’s helpful to do what I do and simply leave your residential property out of the asset column altogether (don’t forget it has to be included in your expenses column though, because you still have to pay the bills every month).
If you are still paying a mortgage on your residence, record it as a liability since the monthly mortgage payments would appear under your expenses column. If you rent your place, then your monthly rent is an expense but would not appear as a liability.
This is also called net worth. It is the difference between your total assets (excluding the house you live in) and your total liabilities. When this amount reaches $1,000,000 you are officially considered a millionaire.
While this is the figure that excites most people, it doesn’t bother me very much. I am more concerned with my retirement ratio. Still, the reason you want this figure to increase is because your passive income usually increases when your net assets increase.
This is your full financial picture. On this single page, you can track everything that is happening in your financial life.
Before you make any new financial commitments, or make any significant financial decision, look at this page and ask in what direction that decision will take you. Very simply, you want the figures in the left hand columns (ie income and assets) to go UP, and the figures in the right-hand columns (ie expenses and liabilities) to go DOWN.
Exceptions apply, of course. You can allow your liabilities to go up when it results in an increase in your net assets or income, for example taking on a mortgage on a second investment property which (a) increases your passive rental income, and (b) increases your assets over time as the mortgage is paid off. This works because the overall effect is to increase rather than decrease your wealth and cashflow.
As we head into a new year, one which promises to be financially challenging for many people, this is a good time to get control over your cashflow and wealth situation. So get this done up, and stick it somewhere you can see everyday.
What gets measured gets done.
– Sir Ian Kennedy
Final personal note: I have it as an Excel worksheet on my desktop, and used to look at it everyday until I got my finances under control. Now I update it once a month just to keep track of what’s happening. So you may have to put in more effort in the beginning until, like all skills, it becomes second nature.
This is Part 4 of a 4-part series: