A few weeks ago, I shared a monster list of ways to make more money. These weren’t cheesy chores or slimy scams, but legitimate ways a person could earn extra income if they needed. Most of the suggestions were drawn from GRS reader stories, from my friends’ lives, or from my own experience. They’re ways real people make real money when times are tough.

Positive cash flow is the foundation of personal financeAfter I posted the list, though, I had a few people send e-mail or leave comments asking, “Why bother?” They wanted to know why I constantly harp on boosting your income.

It’s been nearly three years since I preached my complete “cash-flow” sermon. Today I’m going to preach it again. This will be review for long-time readers (or for folks who’ve read Your Money: The Missing Manual). For everyone else, one of the core tenets of the Get Rich Slowly philosophy is this simple truth: To build wealth, you’ve got to spend less than you earn. It all boils down to cash flow.

Cash flow basics
If cash flow sounds like an accounting term, that’s because it is. But don’t let that scare you — it’s easy to understand. For any given time period, cash flow is what you earn minus what you spend. I call this the fundamental equation of personal finance. When written as a math formula, it looks like this:

[CASH FLOW] = [WHAT YOU EARN] – [WHAT YOU SPEND]

Simple, right? That’s second-grade math. But don’t let the simplicity fool you — this is a powerful concept. This formula tells us two things:

  • If you spend more than you earn, you have a negative cash flow. You’re losing wealth and in danger of going into debt. Or, if you’re already in debt, you’re digging the hole deeper.
  • If you spend less than you earn, you have a positive cash flow, which will let you climb out of debt and build wealth.

For example, if your income is $4000 per month and your expenses are $3500 per month, you have a positive cash flow of $500 per month. But if your income is $4000 and your expenses are $4500, you have a negative cash flow of $500.

The greater the gap between earning and spending, the faster you build (or lose) wealth. This may seem obvious, but smart personal finance really is this simple. Everything else — clipping coupons, saving for retirement, asking for a raise — is done in support of this basic idea.

The power of positive cash flow
Now, if you’re like most people, when you begin to realize the importance of smart personal finance, the first thing you do is focus on finding ways to cut your spending. This is great. Frugality is an important part of personal finance, even for those with high incomes.

Pinching pennies is an important part of personal financeLet’s say your monthly income is $4000 a month, as in the example above, and that your monthly expenses are $4500. You have a negative cash flow of $500, and it’s been that way for years. As a result, you have maybe $20,000 in debt, but that debt is growing by $500 every month.

By making some changes, you find that you’re able to drop your expenses to $4000 per month, which is exactly equal to your income. Your cash flow is zero now, which means you’re not taking on any more debt, but you’re not gaining any ground, either.

You go back to your budget and decide you can make some serious sacrifices. You give up cable television, plant a vegetable garden, and start taking the bus instead of driving to work. These sacrifices (and others like them) allow you to trim another $500 per month from your spending. You still have a monthly income of $4000, but your expenses have dropped to $3500, giving you a positive cash flow of $500. That’s $500 a month you can use to pay off your debt. At that rate, you’ll be debt-free in 40 months.

Note: Of course, if you had no debt, you could use this positive cash flow to save for retirement and other goals. Positive cash flow is a requirement to get out of debt and to build subsequent wealth.

Why your income is so important
The above numbers are just a convenient example. In real life, things aren’t always so simple.

In fact, I’ve heard from many readers who say they’ve cut all of the fat from their budget, that there’s nothing more they can give up, and they still can’t make ends meet. I also hear from readers who have a positive cash flow, but it seems like a pittance compared to their debt or their savings goals. Sure, they generate an extra $100 over expenses each month, but they have $50,000 in debt. At that rate, it’ll take more than 40 years to become debt-free!

It’s in situations like this that boosting your income becomes vital. Remember, there are only two ways to boost your cash flow: increase income or slash spending. If you’ve already slashed spending, your only option is to increase your income.

Let’s illustrate with an extreme example. Pretend you’re magically able to survive without spending any money. Your bare essentials — food, clothing, shelter — are provided, so your base costs are nothing. If you want to save for the future or enjoy conveniences (hot water!) or luxuries (a pillow!), you’re not going to be able to afford them by cutting costs. (Your costs are already nothing!) The only thing you can do is earn more money.

Another advantage to boosting income is that — in theory — your earning potential is unlimited. You’ll never cut your costs to below zero, but you can continue to increase your income in lots of little ways. And even after you’ve paid off your debt, extra income can help you build the life of your dreams.

Income is the gateway to wealth
Boosting your income helps you build wealthSo why do I harp on boosting your income? It’s simple, really.

I know several people I’d classify as wealthy — including the real millionaire next door. Not one of these folks became rich by pinching pennies. Each readily admits that frugality helps them keep the money they earn, but to actually get the money? They had to boost their income somehow: starting a business, working long hours, or taking risks in the stock market.

Yesterday’s reader story illustrates this point perfectly. In the comments, Jacq explained how she managed to save enough to become financially independent at age 45:

I got pretty aggressive on the income side of things. It wasn’t so bad because I saw it as a finite period of time, not something I’d have to do for the rest of my life. This past post on GRS could have been written by me.

My story is similar. Just a few years ago, I was deep in debt and falling further behind. Today, I have a very comfortable life. Honestly, I feel wealthy. Yes, I had to develop thrifty habits in order to take control of my finances. But what really really helped me become debt-free was boosting my income. And since becoming debt-free, I’ve managed to meet many of my goals (traveling to Europe and Africa, for instance) by finding ways to make more money.

So, this is why I’m so adamant that your earning power is important. Your income and your expenses both play key roles in determining your financial fortunes. Increasing your income makes you rich; slashing your spending keeps you that way.

This article is about Basics, Entrepreneurship