In this article I would like to discuss a trap most of us can fall into very easily unless we consciously set up a structure to prevent it from happening to us. This trap is the miscalculation of how much money really is “My Money”. Let me explain.
I define the term My Money here as meaning "the money I can freely spend on whatever I want without restrictions".
Most people would normally regard their income for the month as “My Money”. Let’s say they receive $10k each month after tax in pay, so they would generally consider that $10k as “My Money”. So when they are looking at a $200 pair of shoes in a department store, their mind would quickly calculate that $10k is much greater than $200 and so draw the conclusion that they can afford it. The trouble is, when you do this same mind trick over and over again, many times in a month, you will quickly find out that you actually don’t have enough money to cover all your expenses.
So where is the problem?
The problem here stems from a misunderstanding of the definition of “My Money”. In reality, the formula should look something like this:
My Money = My Income minus My commitments
or to more fully define it:
My Money = My Income minus My Future Commitments (e.g. savings & investments for the future) minus My Past Commitments (e.g. debt repayments) minus My Current Commitments (e.g. living expenses such as utilities, food & kids education, etc).
So let’s look at someone with a $10k income for the month. If he has committed $2k to save for the future, has a $3k existing debt repayment obligation and $4k worth of ongoing living expenses, then for this person “My Money = $10k – $2k – $3k – $4k = $1k”. So when you go around finding something outside of your existing financial commitments you want to spend money on, how much of “My Money” should you be thinking with? Only $1k! That’s right, you only have $1k to play with, not $10k! The rest of your income is technically not “your money” to spend, as you have already committed it to other things so you can’t really make new financial commitments with it. Unfortunately, most people in the world in the same situation as this walk around thinking that they have $10k to play with instead of just $1k. Therefore they often don’t know what hits them when they run out of money to pay their bills.
The same confusion can be seen in many areas of our lives and can cost us quite dearly:
- In time management. When someone asks you whether you can do something for them next week that might take up 2 hours of your time, in your mind you think you have 7 x 24 hours next week, so the answer is obviously yes. After you make a few more similar promises you find yourself not in a position to fulfil your promises as you have run out of time.
- As a business owner. When you receive $10k revenue for the month as a business owner, and a staff member asks you for a $1k expense on top of all your existing expenditure, your mind tricks you into believing that you have $10k to spend on anything you want. Do this a few times and suddenly your business runs out of money to pay its bills.
- When self-employed. A lot of newly self-employed people make this fatal mistake: when they are working for someone else, they usually find that they may be responsible for business revenues that are often 10 times their own wage. They think to themselves: I could have half that income and still be better off financially if I run my own business. Statistically 90% of businesses fail in the first 5 years, and 90% of the remaining fail in the next 5 years. So what goes wrong? One of the key confusions is that when a self-employed person receive $10k income, they should allocate their money something like this:
1. 10% to marketing & lead generation;
2. 10% to sales & client relationship management;
3. 10% to production & product delivery;
4. 10% to IT, HR, down time & leaves;
5. 10% to training, quality control & knowledgebase;
6. 10% to accounting & finance;
7. 10% to product innovation, legal, risk management & industry compliance;
8. 10% to work facilities, utilities & stationery;
9. 10% to taxes on profit;
You can easily see that all of the above components are necessary to run a business. Missing any one of them will hurt your business sooner or later. So what percentage of the business revenue can you really consider yours? About 10% if you are lucky enough to have your business revenue high enough to cover all your expenses. But most self-employed people never see or set up a structure like the one above. Instead they spend most of their revenue as if it was all “My Money”. No wonder they rarely grow their businesses any larger as too many key parts of a functional organization have not been given enough nutrition (money) to keep them alive.
So here is a new mindset that could help you do better financially. Let’s say you choose to follow the general rule of thumb that only a maximum of 10% of your personal income or business income can really be considered “My Money”. If you do you will quickly realise that whenever you are careless about spending $1, you are really wasting $10.
For example, a business owner who didn’t pay attention to prevent an unnecessary loss of $50k, is really costing the business $500k worth of revenue. Which can mean, in a typical Australian firm, about 50 people working for the whole month for nothing! But if he did his best to avoid the loss of $50k, he has saved the business $500k income (or generated $500k worth of sales revenue). Which means the whole 50 staff can have one month worth of holidays and it wouldn’t make any difference to the business!
So the key here is to put some structure around the money you receive to clearly define what it is to be used for. (This is something similar to our Language of Money program that some of you have completed successfully and are now using in your lives). With the proper structure and thought processes around money, you have predefined allocations that give you the freedom to do whatever you want with the money that you can truly consider as being “My Money”.
Until next month, happy investing.
Want to learn the ‘Language of Money’ to master your cashflow and take your finances to the next level? Click below to find out how: