Learn What The Rich Know: Pillar 2 - The Basics of Accounting

• “It’s not the numbers, but what the numbers are telling you. It’s not the words, but the story the words are telling you.”

• “My banker has never asked me for my report card. He’s only asked me for my financial statement. Your financial statement is your report card for life.”

• Numbers are like words—learn to read them and you’ll grasp the story. Learn to read and analyze them, and you’ll be able to change the plot to your liking.

• An asset puts money in your pocket, whereas a liability takes money out of it.

• Rich Dad wouldn’t consider your personal property an asset. Why? Because it doesn’t produce income.

• “The reason most people suffer financially is because they purchase liabilities but list them under the asset column.”

• The term expense here refers to the total payment, including principal payment and related interest.

• Many people purchase homes with the expectation that they’ll increase in value, but there is no guarantee of this, and some homes actually decrease in value. Only when a home is sold for a profit can it be considered an asset.

• “Every time you owe someone money, you become an employee of their money. If you take out a thirty-year loan, you’ve become a thirty-year employee.”

• Debt is a liability because it is money owed to someone else.

• Credit cards easily seduce the unwary into debt. Because no money exchanges hands, it may seem as if something is being purchased for nothing.

 

 

• It can be financially smart to carry good debt; it is never financially smart to carry bad debt.

• But debt isn’t always a negative thing. There is bad debt and there is good debt. 
• Bad debt is money borrowed to purchase doodads such as clothes, cars, or electronic equipment. You cannot expect to get a financial return from something purchased with bad debt.
• Good debt is debt that allows you to purchase assets.

• People who cannot control their cash flow work for others; people who can control their cash flow work for themselves or have others work for them. 

• There are three basic types of income: earned, passive, and portfolio. 

• Earned income, which is taxed at a higher rate than other forms of income, is the salary or wage you are paid by an employer for doing a job. Earned income also includes tips and selfemployment wages.
• Passive income is money generated by a business or real estate property. Business or real estate owners aren’t actively involved in generating passive income; the money they have invested in assets is working for them.
• Portfolio income is a type of passive income; it is income derived from a collection of paper assets such as dividends, stocks, bonds, mutual funds, or royalties from patents and license agreements. Portfolio income also includes interest earned from a savings 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; if you can sit back and let your assets work for you, you have passive or portfolio income.

• Your expenses are all your payments, that is, your total cash outflow, each month.

• “Income is money in; expense is money out.”

• Income pays expenses, and if you don’t have enough income you may have to incur additional debt to pay your expenses.

• A doodad is an unnecessary and sometimes unexpected expense or item you purchase that does not put money in your pocket. Doodads can slowly and  nexorably deplete your income—or serve as incentives to make more.

• Unlike personal expenses, business expenses are paid with pre-tax dollars. Of course, the expense must have a valid business purpose.

• The balance sheet indicates how much money you have and how much money you owe, and the difference between the two at a point in time.

• “People who are not aware of the power of a financial statement often have the least money and the biggest financial problems.”

net worth = assets – liabilities

• The income statement, also called a profit and loss statement, measures income and expenses. One section of the statement lists all income—either earned, passive, or portfolio—while the other section lists all expenses.

• “Most people fail to realize that in life, it’s not how much money you make, but how much money you keep.”

• Income statements and balance sheets have a symbiotic relationship. The income statement helps in determining whether a balance sheet entry should be listed as an asset or a doodad.

• The income statement starts with gross income and ends with net income. Gross income is money earned through a job or from a business or investment. Net income, for our purposes, is that portion of gross income pocketed after all expenses have been deducted from it:

net income = gross income – expenses.

• Cash flow refers to the stream of cash coming in as income and going out as expenses. How cash is flowing determines a person’s degree of financial freedom.

• “People who lack control of their cash flow make people who are in control of their cash flow rich.”

• “Rich people acquire assets. Middle class people acquire liabilities that they think are assets.”

• “If something is a liability, make sure you call it a liability and watch it closely.”

• It’s true that the rich have expenses, but their income covers their expenses and they continue buying more assets, which generate more and more income. Hence the saying, “The rich get richer and the poor get poorer.”