We used to believe that the more money you make, the wealthier you get. But personal finance is more than working hard at the office.
Most of us see it as a solution. Money brings freedom and choices, and it’s tempting to think that life will improve once we get more of it. Have you ever found yourself working for a promotion or project only to end up on a similar spot to where you started?
Forget about those promising numbers. How much do you actually keep? Deduct living expenses, costs, emergencies, taxes, and see what you get: an expectation gap.
The first step to improve your finances is to know yourself. What’s your net worth, cash flow, or net income? Do they all have the same relevance? How far can you get with a high net income?
The Net Income Formula
Net income represents the remaining amount of revenue after paying for expenses:
Revenue – Cost of Goods Sold – Expenses = Net Income
Gross income – Expenses = Net Income
After you make money, part of it distributes for production costs, taxes, and emergencies. Some spendings are essential (living expenses) while others categorize based on the return:
- If the money you spend produces more, you made an investment.
- If you get negative returns, we call it a liability.
You can get a clear picture of your finances by tracking your net income. But when it comes to long term projections, it doesn’t offer enough information. We will need to include other terms to the definition:
Net income shows the general profits earned for a period, whether it’s monthly or yearly. However, this period proves inaccurate— if not arbitrary— to register all the business operations.
- What if you close a deal this month but don’t get paid until the next one?
- If you pay salaries the 15th of every month, your yearly statement will show two weeks worth of unpaid salary.
- Losing money can be part of a strategy to increase net worth.
Although it marks profitability, it doesn’t mean the company has such funds available. Accountants prefer to lock at both factors to determine financial health:
- Net income excludes any possible expenses: costs, taxes, deductions. Cash flow statements will not include non-cash charges: deductions, interest, or impairments.
- A higher net income involves a better company’s valuation. More cash flow increases the chance to cover operational costs and debts.
- Net income means very little without the cash flow context just as cash flow does without net income. You need both to differentiate expenses from investments. Otherwise, all losses would disguise as negative, and all benefits would look positive.
Consistently positive cash flow could be anticipating a net income increase in the long term.
Net Income VS Net Worth
So far, we’ve deducted all expenses to calculate our net income. If we chose to take the amount out of the company, that benefit would be our net profit. But how much do you actually keep?
Once you make positive returns, you decide whether to spend it on investments or liabilities. Your net income may show how profitable your business is, but not how much wealth your company has created. The owner decides the rate they want their company to grow.
In the early stages, businesses are rarely profitable and require a bit more funding. A founder may have a lower net worth because they put all their money for future expansion.
But what if the owner is a high-income earner? What if they’ve spent years in business with a low, if not negative, net worth? They might be making poor financial decisions, such as discretionary spending.
Net worth is an accurate indicator of the company status when combined with net income and cash flow metrics. Increasing net worth over time reveals a person with high financial intelligence knows how to think for the long term.
Despite the good news for investors, net worth is just that: potential. Net income and cash flow are the only concrete numbers at the end of the day.
High net worth can be a reliable record of financial success to attract new investors. The question is, how do you trade that value? If your net worth is illiquid, it may not be that practical.
- Not only net worth is an estimate. It doesn’t relate to your actual purchasing power as cash flow does.
- The market valuation changes your net worth every second. It also affects your cash, but it’s far more concrete and liquid.
- Your overall cash flow is more liquid than your net worth. Positive net worth and negative cash flow may stop you from reinvesting in the business unless you reduce your net worth.
Lastly, your net worth varies greatly. As you grow your wealth, it may be more and more dependent on large-scale economic events. Imagine what it would be like losing your net worth overnight. How would you get back up?
With cash flow, it’s easier. Your income streams will continue to generate the same recurrent amount. It’s fast and easy to reinvest.
Can You Have Negative Income?
A company can have positive cash flow while reporting negative net income. One can borrow money to increase the company’s liquid assets, but it doesn’t represent profitability.
Numbers also change based on:
- Depreciation: As your asset depreciates, your net income decreases. However, your “cash inflow” doesn’t count until you sell the asset. (negative income, positive cashflow)
- Timing: You may have closed a deal with a client and still show different cash flow, depending on the payment date. If it’s still pending, net income still shows as positive, but your cash flow will count all the associated costs to the sale: costs of goods, operational expenses, fees, and so on. (positive income, negative cash flow)
Mind that negative cash flow doesn’t involve a loss, and positive numbers don’t mean profit. Even net income can look misleading without comparing it to cash flow.
In short, whenever an asset changes its value, it affects your net income, not your cash flow necessarily.
Can You Manipulate Data To Increase Net Income?
Some people believe their net income is somehow unfair or wrong. They can’t justify why others take a chunk of their earnings, so they try to cut corners.
- Change the accounting method. Once accountants choose one, they stick to it regardless of others that may be more effective. If you change your system, so will do the numbers. Dishonest people will hide this change and choose the one that benefits them the most.
- Delay/anticipate revenues and expenses. If people get a due date to distribute their benefits, they may underrecord revenue and wait past that time to report it. For example, a retailer may sign a long-term contract with a manufacturer for a discount. The report would show lower expenses but ignore how often they happen or for how long.
These techniques may increase your net income in the short term but increase the risk of getting caught for fraud. Failing to report properly may cost more money than what you owe, and when applied to large organizations, it may lead to serious penalties.
You should not, however, confuse tax evasion with avoidance. Everybody has the right to avoid expenses but not to evade the necessary taxes.
How To Really Increase Your Income
More income means faster wealth generation. Later, you can use that money to contribute to people you care about, follow your passion, and achieve financial freedom. It may not happen overnight, but it definitely doesn’t need to take decades to get there.
There’s a strategy to increase your net income, whether it’s saving, managing, or earning more.
#1 Learn how to negotiate
Do you think you’re adding more value than the compensation you get? If so, don’t expect others to “wake up” and realize how much more you should be making.
Although it may lead to rejection, the worst strategy is to never negotiate in the first place. Don’t dissuade yourself with false beliefs: “They will reject me no matter what I offer.” “They are too busy.” “They won’t promote me because they’re short in funds.”
As long as you overdeliver with results your boss considers valuable, there’s no excuse for better pay. Use this video to get started.
#2 Don’t lose money
World-class investors follow this rule, even if that means earning less. But how can you improve your finance if you care about not losing more about making?
Don’t get it wrong. Investors do care about making money once they find an opportunity. But before they commit, they weigh risk and reward. If the risk is unacceptable, they don’t care how great the prize sounds. Why?
Imagine you have $200 and lose $100, %50. Now, you need to work twice as much (100%) only to get to the same spot, $200: not a smart use of your time.
The opposite is also true: if you risk very little for a large reward, you do it even if the odds were against you.
You may never be financially free if you keep trading hours or dollars. An average income will only be enough to cover basic needs if we consider: price increases, crises, accidents, demotions, and other common events.
Passive income streams help you boost your personal economy without investing much time on them. They may require hundreds of hours to set up but only take minutes to maintain.
How much value do you offer? How many people can benefit from it (millions, in case you sell online)? How often do they buy? Scalability is key when starting a business. Once you have income systems without you having to invest time, you can keep working the way you enjoy, stress-free.
#4 Adopt an essentialist mindset
Exponential growth sounds amazing. But in the beginning, things move slow, and every dollar matters. You will increase your income much faster if you get rid of everything that’s slowing you down, even temporarily.
Be smart with your spendings. At the same time, learn to recognize investments, whether it’s buying better tools, automating, or delegating.
#5 Invest in yourself
All the preparation in the world still won’t protect you against the world’s uncertainty. What matters isn’t what you earn, but who you become in terms of skills and net worth:
How fast can you generate wealth?
Can you generate income in any circumstance?
Are you growing your personal value, or “just making money?”
Personal improvement brings financial confidence, which allows you to succeed in more opportunities. No matter what goes wrong, you continue to make yourself money because of what you know: your net worth. Here’s what net worth means in today’s economy and how to increase it.