The Key To Being Rich

We see an argument taking place in Washington right now regarding the "fiscal cliff" that the United States appears to be facing.  At the core is the debate whether to cut spending or raise taxes.  This is the same argument the two parties engaged in for a hundred years.  However, it seems that the country is at the point where something needs to be done.  Without action, horrific financial consequences are bound to affect the country, or so we are told.

Two Sides of The Equation

I am a big believer in looking at both sides of the equation to determine what the proper course of action is.  Sadly, few seem to have this ability because they opt to only focus upon what they are conditioned to believe.   This is as true in personal finances as it is in politics.  Tunnel vision is something that we all need to be mindful of if we are going to uncover our proper path of action.

At this time, I am not even going to offer up a solution to the United States' fiscal cliff.  There are much brighter people (well that might be debatable) who are paid good tax dollars to figure this stuff out.  Personally, I would feel more comfortable with a bunch of 23 year old men and women than what is presently there.  Nevertheless, I am certain we will see more bickering with each party holding to its' core position.

 The one solution I can offer up is regarding the income statement.  One of the fundamentals in wealthy building is the ability to read and understand financial statements.  Without this ability, one is destined to walk aimlessly through financial affairs.  When this happens, people who thought they were doing well suddenly find out they were not.  One of the most basic tools is the income statement.

For those unfamiliar, basically the income statement measures incoming and outgoing money.  The goal is to determine whether a profit or a loss was made during a specific period of time.  All expenses are deducted from the income to arrive at the profit or loss for that time frame.  Once that is done, different periods are compared to see if a company (or individual) is improving or not.  This is valuable information.

Notice how there are two parts which this financial tool focuses upon.  Income and expenditures are both tracked.  Businesses think nothing of this but individuals exist in a different realm.  If you are to create wealth in your life, it is crucial you understand and are willing to concentrate on expenses as well as income.

I Want A Raise

How many times do hear this uttered?  It is commonplace for employees to complain they are not paid enough and want more money.  Certainly, this might be a factual complaint depending upon the situation.  Many people do outstanding work which is deserving of greater pay.  Nevertheless, it is important to realize this solves nothing.

I am going to guess that if you asked 100 people whether they would like to increase their income by 10%, you would get a unanimous answer of yes.  There is not a single person who instantly would not like 10% more money in his or her paycheck.  It only makes sense that if one wants to get ahead, earning more money is how that is done.

Or is it?  Bringing in more money is a component to increasing one's wealth.  When more money is earned, there is the possibility that the income statement will improve.  I write possibility because most people realize that when more money is earned, the tendency to spent more also emerges.  Hence, instead of improving the income statement (expenses deducted from income), the bottom line remains the same at best.  In a fair number of cases, the  person actually spends incrementally more money than was earned in the raise through credit.

Another way to look at the situation is to go back to those same 100 people and ask them if they would like to cut their expenses by 10%.  Obviously, the answer is going to differ greatly.  Few people are willing to cut their spending.  Yes they want more money but the idea of cutting back does not register as a gain in their minds.  This is in accordance with one who does not understand the income statement.

The fundamental truth is that if one wants to amass wealth, spending needs to be curtailed.  If you look at the net effect on the income statement, you understand why this is so.  As one reduces expenses, the net at the end increases even if income remains the same.  We see this in business when layoffs are announced in response to flat or declining sales.  Yet individuals rarely take this approach when looking at their own budgets.  

It is best to remember that both income and expenses are important components to building wealth.  Definitely, we all want to receive more money regardless of the source.  However, that is something that is often out of our control.  The one aspect that is within our power is the amount that is outgoing.  While there are certain facts of life like shelter, food, clothing, and the expense that goes along with that, there is also a great deal of discretionary spending in every household.  It is important that you get this aspect of your life under control.  This is where many people turn a net profit into a net loss (or break even).  Reduce your spending and invest the savings.  This is the key to being rich.  Everything else falls in line behind this idea.

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