Wealth creation- Ratio of spending to income

So until now, you have learnt the simplest definition of what is an asset and what is a liability.

To revise again, ASSET is your belonging which puts money in your pocket, while the LIABILITY is your belonging which takes money out of your pocket.

If you want to be rich you must buy assets, lots and lots of assets. You have to allocate most of your income in purchasing assets, but what's the point of making money if we can't buy liabilities? Because we have longing for all the costliest liabilities, e.g. fancy car, huge flat screen television sets, home theatre systems, automatic home appliances, latest smart phones, fancy gadgets, the list even goes to luxury yatchs, private jets, vacation houses, maids and servants, personal assistant etc.

To understand how to do it, you must imagine you are doing a business, even if you are not a businessman. (what is a businessman? is another important topic to write a post on, you will soon get to read it on samanyabuddhi.blogspot.com , stay tuned.)

So now you are imagining that you are doing a business, you are the CEO and managing director of the business. Your business is managing your family. You and may be other family member of your family have incomes, may be from job or self employment or business or rental etc. That is your income or you can say income from operations, and then you have to pay the utility bills, grocery bills, servants salary if there are any, tuition fees of your kids, hotel expenses, entertainment expenses, purchase of clothes, traveling expenses, loan EMI's, fuel expenses etc.

So these things make income statement or cash flow statement of your business(it tells you from where your money is coming from and where it is going)-

Income statement / cash flow statement-
Income-
1) My salary -
2) Spouse's salary-
3) Interest on deposits-
4) Dividend on investments-
5) Gifts-

Expenses-
1) Grocery bills-
2) Utility bills-
3) Traveling expenses-
4) Maintenance of vehicles-
5) Children's education-
6) Healthcare expenses-
7) Gym memberships-
8) Entertainment-
9) Miscellaneous expenses-
10) Various taxes-

There can be other incomes and expenses too which I have not covered, but you can include them.

If you do it, you will get a clear picture of, from where and how much money is coming and where it is going. The money remaining after the expenses is your free cash or savings. You can use this free cash to buy assets, which will add to your income.

Similarly, you can make list of your assets and liabilities on a sheet, known as balance sheet.

Assets- (which put money in your pocket)
1) your job
2) property(only if it is putting money in your pocket or it's price is increasing more than it's expenses- in short putting money in your pocket)
3) shares of any company you are holding (again if putting money in your pocket)
4) fixed deposits
etc.

Liabilities- (which takes out money from your pocket)
1) your car
2) your smart phone
3) your tech gadgets
4) loans
5) different memberships
6) shares or equity in a loss making company
etc.

So now you get a clear picture of from where your money is coming and where it is going, also which of your belongings are putting money in your pocket and which are taking it out. Once you get the clear picture it is easy to start the reconstruction.

The reconstruction process involves getting rid off the unwanted liabilities and purchasing more of the profitable assets.

But the question is up to what extent we have to do it for the best results?

The answer to this question lies in the financial statements of the successful companies. How these companies spend their earnings. The dividend they give out is expense to them while retaining of earnings to purchase or expand the business is like buying assets for them.

So the first on my list is The company managed by legendary capital allocator Warren Buffett and his business partner Charlie Munger, The Berkshire Hathaway.

Berkshire Hathaway has paid dividend, hold your breath - ' only once' under Warren Buffett's part ownership, but that too because Warren Buffett does not had sufficient percentage holdings to stop the dividend payment. After that Warren Buffett have increased his equity in the company so much as he had virtually total control on the company's decisions. Since then Berkshire Hathaway have not given any dividend. That is the company had used all it's income to fund new investments and expansion of existing profitable operations. Berkshire Hathaway is the extreme case of retained earnings. None can blame Berkshire Hathaway for not paying any dividend because it had used the money for increasing it's income very efficiently.

But if we look at other growing, profitable and debit free companies, we will find that, they are sticking to the 80-20 rule.

It's not a rule it's just an arbitrary value. These growing, profitable and debit free companies reinvest their 80% of the earnings and distribute the rest of the 20% as dividend to the shareholders. In this way the shareholders of the company has money to spend and also have a growing business(growing income).

I always try to stick to this 80-20 rule. It's a no brainer and it works. Now a days most of the average families save less than 10% of their income and buy assets (if they are not paying home EMI's). So it is hard for them to reach that 80% mark, but you can start increasing 1% at a time. You can not convince your family and yourself from directly moving from 10% to 80% but you can certainly convince and achieve the move from 10% to 11% and then from 11% to 12% and so on until you reach your target. Use the proverbial ' Boiling Frog Syndrome ' to your advantage.

That's it for now.

Hope you have got the basic idea about how to look at your financial situation and how to improve it for your betterment.

See you soon.. Till then happy investing...

Sumit
The POWER is when,
You use ODDS,
To get EVEN.