It is important for everyone to understand basics of personal finances and also effectively use them .
Any individual has two types of income . Assured income as well as income which is not assured.
Assured income is one which will keep flowing whether you are personally working or not . For example, Rentals, dividends, royalties , Interest , etc .
On the other hand income which is not assured is one which stops flows the moment you stop working. For e.g Paycheck, Bonus, etc ..
Similarly , there are broadly two types of expenses .Fixed and discretionary. Fixed expenses like , taxes, Debts, Insurance, household expenses , etc .
To achieve ” personal financial freedom ” we should be concerned about a Flow , which we can term as freedom flow . This is the difference between the Total expenses and the assured income .If the result is negative , then one can smell freedom . On the other hand if the result is positive , it implies continued imprisonment in the trap of debt.
There is a simple formula by which one can determine how long would a person take to achieve “personal financial freedom” .
N = Freedom Flow / AIOP x Plough back
Where , N = No of years required to achieve threshold of freedom .
Freedom Flow = Total expenses – Assured income
AIOP = Assured Income that can be generated as a percentage of the plough back. A 10 % conversion is a good reference .
Plough back = (total income) – ( total expenses ) . This is the money available for conversion to assured income .
To take an example, if for a person ,
Assured Income = $25,000
Total Income = $ 1,00,000
Total Expenses = $ 85,000
AIOP = 10 %
Then the plough back is $ 40,000.
So , as things stand , the number of years required to reach the threshold would be :
60,000 / .1x 40,000 = 15 Years .
Now , let us say the person is able to reduce his total expenses by 20 % and improve his AIOP to 15 %, then the number of years required for him to achieve threshold would be :
43,000/.15 x 57,000 = 5 years .
Such is the power of this equation , which essentially means that we should
Keep the freedom flow as low as possible . Increase income and reduce expenses .
Maximize the plough back .
This formula , however does not take into account inflation . It is best to use this as an indicative tool rather than dissect it for accuracy .