In this article we will be talking about the importance of finance in our lives. Long has gone the time when different articles and things were being exchanged by people for buying the needs. The buying of needs by exchanging with goods that they did not need was called a barter system.
But then the barter system was so uneven and was so much unorganised that a new system was brought into play. This system is what we now call as currency. These days even multiple countries are going for a common currency like the Euro or other currencies are present in each country. But each of these currencies are still connected to each other in the form of exchange. This medium for our work helps to save, to progress. We need money in the form of currency. It is very important to see and notice a tangible difference and progress in our life.
The two important tools
To understand how we spend money and how we save them, finance has given us two very important tools. These tools are known as income statements and balance sheets. An income statement is essentially a difference between what we earn or what money we get and what money we spend or what reduces from our income.
The next tool is the balance sheet. It is the difference in asset and liability. Thus when we have more expenses and when we have more liabilities, we are having a poor financial status. But when our income is more and is from diverse channels and when our assets are more than our liability, we are having a good financial status.
Comparison between income statement and balance sheet is also popularly known as Profit and Loss statement. This is perhaps, the most easiest and the most important definition of our lifestyle. As mentioned in the book Rich Dad Poor Dad, this is being presented by two very easily drawn boxes and it represents the balance sheet.
What happens in a cash flow pattern of an asset?
An asset is something that which you invest into and it starts to grow and become profitable over a duration of time. Profit that is earned from an asset starts to give you an income. For example, when you invest in shares, when you invest in mutual funds, when you make your property earn money for you, they all become assets. When your assets are strong your Wellness dimension on Financial Wellness is strong. But for those who are unknown about these two definitions, are living a life which is known as a life of financial struggle.
Such people have more liabilities. For example, they would probably keep on getting personal loans, ornamental loans, home loans and their lives are fulfilled from credit cards mortgages, bank credit, and their income keeps on being spent on completing the liability. They are thus not able to invest more into assets. Or rather their assets are next to none or minimal. People who depend a lot on liability even after having an increased income would still find money being spent out. Money is not being saved. Thus, such people are called a poor people. Their whole and sole income is from their job. They get a salary and keep on spending on taxes, rent, food, transportation, clothes and all the nitty-gritties of their expenses.
Poor people start to earn more as they grow in their experience and work harder work for long hours. They decide to get a few loans, for example loan for house, loan for car, credit card depth, loans for school fees and there could be so many other loans. These are the loans which become their liabilities.
Because of this, they now have one more kind of expenditure. This is interest on loans, something which they wouldn’t need to have, if they were not to go for loans. Now on these loans, their expenses increase. As described earlier, once again taxes, mortgage, car payments, credit card payment, School loan payment.
Rich Person Cash Flow Pattern
Let us have a look at the cash flow pattern of a rich person. How does a person become rich? A rich person becomes so, by having various sources of income. And this could be salaries, income from rent from their properties, income from dividend, from investment in shares and mutual funds, interest from royalties. All of this comes from the accounts which are real estates, stocks, bonds, notes, intellectual property. They do have liabilities and they do have expenses like others. But they would probably have mortgage consumer loans, which they might have taken to buy the houses and the credit card payments, but because their assets are numerous, their income is higher. Thus they would have expenses that are due to mortgage payments, taxes, credit card payments.
But because they have invested in assets, they are having a good source of income.
This terminology is very easy to understand, and is a financial nightmare for a middle class person. A middle class person eventually becomes a hardworking person and starts to get more and more things of desire when their income has increased by a little bit. They want to spend their money on getting more loans and they want to increase the expenses. Usually these expenses are beyond their actual earning capacity. They want to have two houses, they want to have two cars. They want to have a lot of comfort and leisure for which they need to spend a lot of money. Thus, they start to increase their liability and this hard working person gets pulled into what is called a rat race. Then what happens is there are a lot of loans and the credit company then merges these loans into their home loan and causes an increased tenure of 20 to 30 years of their financial liability. For the time being, they feel great, but again the habits of high expenditure become your biggest enemy.