The truth in numbers
The numbers don't lie. They tell a tale of a society living well beyond its means. This is why 80% of Americans are broke and living pay check to pay check.
In the first episode focusing on Financial Sustainability, we discuss the core philosophy and how to position yourself to set you up for a truly unconstrained lifestyle.
Did anyone ever explain to you the responsibilities that we all have in choosing to live in a capitalist society? We might think that we know this, but rarely is this ever discussed. Yet the lack of understanding of capitalism is the downfall of 80% of Americans who are living from pay check to pay check. Listen to this episode as we delve deeper into the world of the unconstrained.
In the first episode, we introduced the context of why you would want to live unconstrained. The freedom that comes with the unconstrained lifestyle is incredible. You get your life choices back, you get your freedom back , your ability to travel and the release of stress from the day to day grind that we have all found ourselves subject to. I introduced the concept of Financial Sustainability, and this is the core methodology that backs our show.
In this episode, we will dive into the methodology of Financial Sustainability, beginning with philosophy. We are expanding on the content from the first episode so if you are new to the show, you might want to listen to the first one and progress forward from there. If you are already up to speed, let’s begin....
Here’s the core concept you need to understand for this episode:
In a world of capitalism, we are all businesses and need to act like one
What do I mean by this? So many of us were never told this, or at least had the raw truth of capitalism explained to us by our parents. Why? Because they probably went through the institutionalized world of education and then corporate work, and came out the other end with a gold watch, 401k and retirement. Sounds nice, and something that government and tax policy enforces (either overtly or covertly). But as we explained in epsiode one, this structured lifestyle that we are expected to fit in doesn’t work for the majority of cases. So to break free of it - to be a contrarian - maybe the only way to survive and thrive going forward.
Let’s understand the reality - regardless of your political or philosophical belief system, if you live in a western economy, you are expected to participate in that economy. That means that you are expected to earn income, pay expenses and participate in the market. Even for the most left leaning socialist, you still have to pay your rent, your taxes, your utility bills, drive your car, etc. You can be as outspoken that you think socialism or communism is a better way, but the reality is that unless you move to China or Cuba or Venezuela, you are stuck with capitalism. If you don’t learn to work with it, you wil be an unhappy victim to it.
FACT: According to Fortune magazine, 78% of all US workers are living from pay check to pay check, and the majority could not service an unexpected $500 expense.
The expectation of capitalism is that we are all participants in a market. It goes back to the core philosophy that you earn income by offering something to the market, and you spend that income back into the market to exchange it for goods & services. Very simple stuff. If the market is left alone to operate (which we refer to as a “free market”) then the laws of basic economics work. Prices are set by those offering something to the market to those that want those things from the market. Price competition is left up to the consumers in the market to dictate - they will pay what they think is a fair price, and the guide to setting the price for whatever is being offered to the market is determined simply by supply & demand. If there is little supply, the vendor sets the price and the consumer has no choice. If there is competition, then the availability of the offering dictates how the vendors compete to get the business. The old adage in the hotel business is true.... The value of an empty hotel room is $0, so the price of the hotel room is set by the demand for it. That’s why it is hard to get good deals in holiday periods for hotels, but easy to get incredible deals in off peak periods. Supply & demand has a natural way of establishing a price point.
When you go to interview for a job, you are the vendor selling your services to a customer base - the employer. You get dressed up in nice clothes, dust off your resume, get to the interview, and attempt to impress the employer so that they may choose you over your competition. Every other candidate is your competition. There is one job, and probably 50 candidates. To the supply/demand curve is clearly in favor of the employer. They set the price point based on the minimum needed to attract the quality of candidate they want. You choose to go to the interview or not, ideally knowing the income range that may be offered if you secure the job. This is stressful for many, but really it is just the market playing out.
Sure, there are those that don’t want to pay much for candidates. But that simply means that quality candidates won’t even turn up for interviews, so it might work for entry level candidates who want to gain experience but it won’t last long for them - forcing the employer to have to retrain over and over again, eventually setting an economic cost that forces them to raise wages in order to attract longer serving candidates. There are those with little to offer, lack of intelligence or wisdom that will force them to continue to only work in entry level positions, but the truth is that those positions are “entry level” - ie. they are designed only for you to ENTER the workforce. Like an onramp, they are not expected for you to drive onto them and park. You are expected to enter, learn, work hard and progress up the org chart. If you don’t do that, then you lose. It is that simple.
So let’s compare this to small business and see why those that succeed in capitalist societies embrace the art of business. First, we know supply & demand dictate pricing. We know that it is competitive and that we have to both seek out opportunities but also be the most attractive option to the market for those opportunities. We know that we define our income levels based on our ability to present ourselves (sales & marketing) but also our ability to negotiate a fair price (closing a good deal). We know that there are many candidates and that sets the price levels. We know that if we were to specialize in a field that had fewer candidates, we would probably get a better price. We know that if we offer experience to the customer (employer) that we can garner a higher price because we remove a lot of the training costs off the customer. We are, in fact, a better economic option in that area.
We know that to continue to generate revenue, we have to wear nice clothes, practice proper hygeiene, have a reliable vehicle to visit the customer (go to work), be prompt, efficient and be seen to conform to the expectations of the customer. Depending on the negotiated deal we make with the customer, we may be working for flexible period of time (freelancer), a pre-defined period of time (contractor) or an ongoing period of time (employee). And that the price point differs depending on the type of role that we have.
You see these aspects of employment or working for a company in some manner are no different to the marketplace of business. But 90% of all employees don’t see it that way. They believe that their allegiance to the goals of the employer should garner them stability and longevity of employment. They spend little time reviewing their competitiveness and just assume that because they have tenure, that they either can’t or won’t be fired. This is exactly opposite to how a free market works. Every day a vendor (employee) offers their services to the customer (employer), they must prove their competitiveness and that are producing a positive return on investment to the employer. That means that if they fail to achieve either of those things, the employer will eventually replace them with either an automated solution (software, robot, etc.) or another employee who is more competitive.
Business exists regardless of how you see your role in a job. You are expected to embrace it if you work in the capitalistic world. You are expected to understand the fundamentals of competitiveness, supply/demand, price discovery, etc. If you want to avoid dealing with all of this, find a position in the government or some protected or artificial environment that allows you to pretend all of the aspects of capitalism away. Or go and move to a non-capitalistic society.
I’m going to assume that isn’t an option. Your problem is that you find yourself in the world of capitalism, and haven’t realized that you chose to be here and that you didn’t realize that there are responsibilties that come with it.
So how about we choose to embrace it, rather than pretend it doesn’t exist? Wouldn’t that be a better strategy? I mean if you have a leaking pipe in your house and it is leaking water, costing you money and damaging things around it, do you bury your head in the sand and pretend it away? Nope. You get up and you get it fixed. You get off the couch and you get busy. You don’t crawl into a corner and continue to be a victim to it. You “attend” to the problem.
You see, in a world of capitalism, those that understand the art of business and embrace it, are best positioned with the skills to be able to master their own economic journey and be unconstrained. Those that choose to either avoid it, or ignore it, become slaves to it. In the same way that pretending the leaking pipe isn’t happening doesn’t end well. If you give up control to an employer, you are constrained. The US has a long history of those that didn’t have control of their destiny being forced into indentured servitude and that didn’t end well either.
You have to think of yourself as your own sovereign entity - your own small business. That you are competing for customers, and you are trying to operate your business as cost effective as possible. Because you realize that it isn’t as much about how much income you make, but what you get to keep from it. If you get excited by the challenge and adventure, then you get and keep the motivation to get up each day and go out into the world trying to make it better. You avoid getting lethargic and you embrace it. Because YOU own YOUR BUSINESS. If you do that, you are more likely to be the person your employer wants, or your customers want. It is about you and your mindset first.
But here’s the deal - like any business, you have to manage two things - your INCOME and your EXPENSES because the simple goal here is to make a profit. Sure there are a bunch of other economic indicators, etc. but they are peripheral to the simple rule that you sell something (INCOME) and you have a cost of doing the business (EXPENSES). And like a business if you understand the numbers, you can chart your course, adjust as things change and ensure you are as optimal as possible. It is all great to have all these “life hacks” but if you have no idea of the totality of what is going on in the business of you and your family, you will get tricked out of your money. And that, my friend, is the root cause of being constrained.
No one willingly wants to be constrained. They become constrained because they take their eyes off the prize of their own personal freedom. Like the caveman who forgets to look behind them, as a saber tooth tiger attacks. There is danger at every corner. To pretend that away just delays the innevitable. But to be prepared and armed for that danger, means you can adapt to it. So the business of you has to be adaptable, secure, protected and constantly scanning the horizon to see any threat coming in the distance.
So important fact you should burn into your memory:
YOU ARE THE INDEPENDENT BUSINESS OF YOU Inc. AND YOU NEED TO ACT LIKE A SUCCESSFUL BUSINESS OR GO BROKE.
Let’s first start with understanding how to measure how your business is performing.
Yep, I said it. Accounting. For most of us, this is pure boredom. But actually it isn’t. Think of accounting not so much as an obligation (like doing your taxes), but more of a “BIG DATA ANALYTICS” about the business of you. Sure, there are tax obligations we all have to keep financial records of our activities. But what if they told you the secrets of what you needed to make more profit?
Because that is the key goal of any business and it now supports the most important statement I’m going to make in this episode, and probably in this entire podcast:
IT IS NOT HOW MUCH MONEY YOU MAKE - IT IS HOW MUCH MONEY YOU KEEP
You probably know this, right? But how many times do you repeat it to yourself? Because in our day to day society we forget it all the time. It is not burned into our subconcious. It becomes an after thought but to any business, it is the core reason they are there. It is all about NET PROFIT.
When I see people saying things like this, “Did you know Jim makes $X salary?” or “I want to earn a six figure income”, or “I just sold my car for $X”, I cringe. Because this should not be the subject of discussion. Not only is it crass in most aspects of society but at the same time it is the entirely wrong discussion to have. The right thing to think of, reward, high five each other over, etc. is a statement more like this:
“I earned $x AFTER I deducted my expenses from my income”
It is the NET PROFIT you made - not your NET INCOME. That is what you are taxed on, but that is what you must know. And you must track it regularly. Get Laser Focused on Net Profit. If you don’t, you will continue to make stupid decisions on expenses, without realizing just how stupid they are. You will continue to pay more for your cable TV bill than you need, and although you might think that you want to be a cord cutter to pay less, there is no rational reason for this statement. Because maybe it is an entirely reasonable expense based on your overall picture. It probably isn’t, but how do you know? How do you know what is a reasonable expense in light of the totality of your expenses? Maybe you could change the car you drive and reduce your costs down over time dramatically? Would it not be better to spend your time focusing on that, than the cord cutting? But how would you know? What tools do you need to know this in a timely manner, so that getting this information doesn’t involve a month of paperwork, spreadsheets, etc?
But also if you understand that the goal here is net profit and that net profit is the subject of tax, it is a double edged sword. You want to show a HUGE net profit. You want to pay the smallest amount of taxes. And this is where your life structure might need some adjusting.
What if I could tell you that if you embraced the art of business, that you could register yourself as a business and you could operate your own personal economics like a business, but you could also get all the perks that businesses get? For example, as a registered business (and check all of this with your CPA), there are deductions against taxes that you become eligble for that you can’t get as an individual. These deductions change with location, tax policy, etc. but there are many things that you get to deduct against your taxable income as a business that you can’t as an individual. For example, as a business, your business related travel in your car is a tax deduction. That means registration, insurance, fuel, maintenance & repairs, etc. You can also deduct leasing a vehicle as a direct business decution. Your phone bill is likely a business deduction, but not a personal deduction. You can take advantage of business having access to retirement savings using SEP IRAs and get high limits on how much you can invest into it. Plant & equipment would be either depreciable or deductible, which might include your computers, TV, etc. You may be able to deduct part or all of your household living costs if you operate your business from home (this is tricky, so talk to your CPA about this). But that could include power bills, cleaning, Internet, gardeners, etc.
You also could get business credit cards that come with massive frequent flyer mileage bonuses that you can’t get as an individual. Your clothing might be considered “uniforms” and be deductible.
And yet you retain other tax deductions at the personal level, like mortgage interest, retirement savings, medical expenses, etc. The best of both worlds.
But you are expected to keep good books. Because there will be more scrutiny on you to prove that your expenses are eligible deductions. I’m here to tell you that you need this anyway - because if you don’t keep accurate and up to date accounting, you can’t see how one decision would affect other parts of your business. What if the cable TV offering was part of an Internet package, and you can write off the entire Internet package for your business? Would that also suggest now your cable TV expenses are deductible tax expenses? Again, I’m not advising you on how you claim deductions, but you should at least have the discussion with your CPA because by registering a business, you may empower the CPA to do far more for you regarding tax deductions than you currently can as an individual.
Let’s talk a bit about basic accounting, because if you don’t know this, you should learn it. I’d suggest taking a community college night course because this is very important to empowering you to be unconstrained.
Introducing the GENERAL LEDGER
I’m going to start to use a bunch of accounting terms and they are not scary. They are pretty simple and if you understand general accounting you may want to skip forward a bit. But let’s start with how things are captured and measured.
Every day that you “transact” in some way, you must record it. A transaction could be receiving money (getting paid) or spending money. It doesn’t matter how big or small each transaction is - they must be captured and documented. Thankfully your bank or credit card does the bulk of the work for you. They record all transactions, and you get a statement periodically (or you can see this often in near real time online as well), showing your transactions, etc. But you might have multiple credit cards or multiple bank accounts, so you need to pull in all those transactions somewhere and and see the totality of what is going on.
This means that you need to have a way to capture all of this, and categorize it. This is less important for income (unless you have a diverse set of income and need to categorize it), but it is more important for expenses. The concept of a general ledger is to have a big filing cabinet in which all of these transactions are put, each with a $ value, and that they are categorized into “accounts”. Accounts are like the files in a filing cabinet. Each has a name, and you put each transaction in the correct file. The general ledger just takes a rollup of the sum total of moneys in those transactions over some time period and tells you how much your total transactions were for that period. Kinda like a database but for financial transactions.
Each account int the general ledger has a name, and is put in a section. The list of those accounts is called a Chart of Accounts. This is to make the calculation of totals easy. Your net profit, for example, is the sum of all income accounts less the sum of all expense accounts. That is a part of it, but not all of it. There is also a way in a General Ledger of showing you your net worth. That is your total assets that you own, less your total liabilities that you owe. I’ll get into more detail about this for the future, but I will say that Net Worth is a stupid number because it doesn’t mean anything. It has the same value as what your house that you live in is worth. It is a pointless number.
Why? Because if you were to sell your house, and cash out with this great value, you still have to find somewhere to live. And if you are just converting asset value to cash, and then using that cash to pay rent, the cash will deplete and you will be poor. And if you just take the proceeds from selling your home and buy another home, you might realize a gain or a loss, but you still have to have a home to live in. Net worth is like that. Unless you die, it can’t be realized in its total form. So while you are alive it is a nice number to have, but it is really pointless as a practical measurement of anything.
Net worth is a number that shows on a report in a General Ledger called a “Balance Sheet”. It simply shows total assets that you own, less total liabilities that you owe, and what your resulting net worth is. A more important report from a day to day management perspective, and the report that will keep you unconstrained is a “Profit & Loss Statement” (or sometimes referred to as an Income statement - a term I don’t agree with at all). A P&L statement shows your income for a period of time, less your expenses and the resulting profit. Nice and simple.
You pick a period of time to roll up the numbers that mean something. I like to focus on monthly because we typically see bills coming in monthly. Like your rent, mortgage, utilities, etc. So if you track your income for the month against your expenses for the month, you can see pretty quickly how well you are doing for the month. And if you pull back on that and look at this for a year or compare this year vs. last year, you get to see a much more interesting view of how you are doing.
Finally an important part about this, and the #1 reason that small businesses go broke is a thing called “Cashflow”. Cashflow is the idea that at any moment in time, you have access to enough cash to meet your expenditure. For example, a business that employs staff typically has to pay them bi-weekly. That means they have to have enough cash on hand (in the bank account) that allows them to write checks that won’t bounce to pay their employees. This is a regular and routine activity that they have that is not tied to more irregular things like income. So their income could come in at any time. Sometimes businesses are seasonal (like a Christmas store or a Travel company when the bulk of their sales are in the holidays), and that means that some parts of the year they make a lot of money and other parts of the year they make less. This fluctuation means that sometimes they won’t have enough money to pay their expenses (like salaries, rent, insurance premiums, etc.) and yet they have to keep operating. So either they have to make a lot of money when they are “in season” and save it, or they have to have access to someone else’s money (ie. a bank loan, overdraft, etc.) that will cost them interest to use it, to get them through the slower times. It is a constant leap of faith to take someone else’s money on the proviso that you will be able to pay it back, especially if you cannot accurately predict income for the future. This is where even the most profitable businesses can go broke, if they don’t have access to the capital they need at the time they need it. Hence by having a budget and projecting out expenses over time, you can track income against it, and build up a pattern of what is happening. Without the proper accounting, you could never do that, which raises the risks of a business owner making a bad decision and not even realizing it.
Do you see the parallels with these things in your life? Even if you don’t consider yourself a business, don’t you go through the very same dynamics and challenges? Do you have a seasonal job? Do you have regular expenses? Do you have times when expenses are higher than others? Like holidays, summer, tax season, etc.? Do you know if you are paying too much or too little for things? Do you take advantage of ALL of the taxable deductions you could be getting? Do you focus on your net worth and forget net profit and realize just how pointless that is? Have you fallen into the trap of using credit cards to fund times when you didn’t have cash on hand for things, and never quite been able to recover from that?
Are you being challenged with temptations to spend money on things that have ongoing monthly committments (like Internet subscriptions, Netflix, etc.) without realizing that if the day comes that your income is interrupted or is seasonal, that you will be forced to fall back to other people’s money to get through any shortfall? Do you even know if you have a shortfall?
Repeating the statistic:
According to Fortune magazine, 78% of all US workers are living from pay check to pay check, and the majority could not service an unexpected $500 expense.
If the 80% of US citizens that are living from pay check to pay check got real with their accounting and started to see themselves as a particpant in a capitalistic society and that in order to have the right tools to exist and thrive in that society, they have to perceive themselves as a business - competing for opportunity, being responsible and knowledgeable for their income and expenses, understanding cashflow and most importantly net profit, they could change that dynamic. It doesn’t take time and surprising the results come fast. You get more money. But since you know the ongoing costs you are going to deal with, you don’t squander the profits. You put them aside because you know that if your income is interrupted, you have the resources to get through that so you can go back to the marketplace and get more income.
This might seem like a very simplistic summary of capitalism at the personal level. But 80% of us were probably never told it. At least not in a 30 minute podcast episode. But if you got this far through the explanation, you now have the knowledge. The devil is in the details which will will get into for the next podcast episode.
So in summary YOU ARE A BUSINESS whether you like it or not, and this is because YOU ARE PARTICIPATING in a capitalist society. Get responsible for your income and expenses, understand cashflow and understand that you might have to learn something about basic accounting and implement some systems so that you get some control back. Because if you don’t have control of this, then you are constrained. By fear, by others who seize the control from you.
Well any small business that has to make decisions on a daily basis to operate as efficiently as possible or go broke would use some form of accounting system for this. And I believe you should too.
This is not an endorsement for any one product, but let me tell you that I manage all of my business entities with Quickbooks. This software from Intuit, is available in a desktop or online version. I choose the Desktop version (on Windows) because it has a finite cost. The Pro version that I use cost me about $200. I can run an unlimited number of companies on it - each has its own company data file. I send the resulting reports and company data file to my accountant each year who files my taxes from it. I use the reports from it to feed a spreadsheet that I use to augment the information from it, but if I was just starting out I could probably do all of this within Quickbooks.
The greatest thing Quickbooks does for me is to automate the downloading of transactions from my bank and credit cards. This can be done regularly and it means I don’t spend a huge amount of time doing my accounting. What I prefer to do is to spend the time reviewing reports and projecting out cashflow plans and looking for missed opportunities. But I get a very quick return on investment on the $200 I spend for Quickbooks - normally by spending time with its budgeting and accounting setup, I can immediately see what I need to do to optimize and improve on my financial position, resulting in something that returns back a multiplier of what I spent on the software month after month after month.
But one piece of advice - don’t fall into the trap that you don’t need to understand basic accounting because you choose to learn Quickbooks. That is like saying I don’t need to understand English or how to write a book, just because I know how to use Microsoft Word. Accounting and it’s rules and fundamentals is probably the easy thing to learn. Quickbooks is just a tool to implement that. Do it in that order - learn accounting first, learn Quickbooks second.
Also if you are serious about setting up your own business structure for your personal finances, I could do 10 podcast episodes on how to do that. Maybe that will happen, but for now you may want to reach out with a local accountant or lawyer in your region who could advise you on local laws and statutes dictating establishing a business in your area. You don’t want to make a mistake with this. My preference is LLCs as entities, but each state has different laws for them. Arizona and Nevada have excellent laws regarding LLCs and some asset protection that comes with them, and you might want to do some Google searches on the pros and cons of this. But again, use local experts to guide you.
It is not critical that you register a business in order to operate You Inc. The advantage will be that you will have 10x the tax deductions through that business than you would have if you just file as an individual or jointly with your spouse. But I do believe that having a business can be the biggest advantage on so many levels, and it goes to the entire theme of this podcast episode:
WE ARE ALL BUSINESSES WHEN WE PARTICIPATE IN A CAPITALIST SOCIETY
So if you embrace that, why not get the advantages of acting that way as well.
Until next time, stay safe and stay unconstrained.