To reach our financial goal, one of the first things that we should do is to figure out what is our financial situation, so as to better chart our path.Â And to do that, we need to determine what are the monthly flow of cash into our pocket and the monthly flow of cash out of our pocket.Â That is our income and expenses, which will define our cash flow.
Income is money that goes into our pocket.Â Some sources of income are:
- Interest on investment
- Rent from real estate
- Distribution from business/limited partnerships
- Capital gain
There are primarily 2 basic types of income: earned income and passive income
Earned income is what you earn when you work for money.Â It is money which you are paid for doing a job as employee (whether you are a manager or a delivery boy) or wages you receive as a self-employed person.Â Earned income is taxed at a higher rate than other forms of income.Â This is the form of income that keeps many people on the left side of the Cashflow Quadrant, including myself.Â Robert Kiyosaki mentioned that these people are typically those who listen to parentâ€™s advice to â€œget a good jobâ€ and ended up in the E Quadrant.
Passive income is money that you generated from the asset you own, such as real estate investment or a business.Â It is called passive because owners of these assets are not actively involved in generating the income.Â It is the money you invested in assets that is working for you, instead of you working for money.Â Passive income is the least taxed form of income.
Besides, earned and passive income, Robert Kiyosaki also defined another income called Portfolio income.Â It is a type of passive income.Â It is income derived from your collection of paper assets such as dividends, stocks, bonds, mutual funds, or royalties from patent and license agreements.Â Portfolio income also includes interest earned from a saving account, an outstanding loan, or some other source.
The difference between earned income and passive or portfolio income is this: if you have to show up for a job you have earned income.Â If you can sit back and let your asset work for you, you have passive or portfolio income.
An expense is the opposite of income. It is money leaving your pocket.Â
Robert Kiyoskai in the book â€œRich Dad, Poor Dadâ€ defined expenses as all the payments you need to make each month, that is, your total cash outflow, each month.Â
- Home mortgage payment
- Credit card payment
- Car loan payments
- Utility bills payments
- Grocery bills
- Travel and entertainment
- All other personal expenses.
Your income pays your expenses.Â And if you don’t have enough income you may have to incur additional debt to pay your expenses.
Robert Kiyosaki defined the term doodad as an unnecessary and sometimes unexpected expenses or item you purchase that does not put money in your pocket.Â It may be a pleasure boat, a dream vacation, a new pair of sunglasses, or a meal you ate in a fine dining restaurant.Â Doodads can slowly and inexorably deplete your income.
However, do you know that doodad is not all bad?Â Robert Kiyosaki pointed out that doodads can also serve as the motivation to make more money.Â Let me give you an example.Â If you are determined to take a dream vacation but equally determined not to pay it on your credit card, you may figure out a way to purchase a new asset that will generate the cash flow to pay for your holiday.Â After you pay for your vacation, you will still have the additional cash flow generated by the asset.Â Â People in the B quadrant of Cashflow Quadrant quickly learn the value of buying assets because it earns them ability to pay for doodads.
Understanding the dynamics of income and expenses is critical to cash flow management.Â People who cannot control their cash flow work for others.Â People who can control their cash flow work for themselves or have others work for them.