Previous posts in this series on prudent fiscal planning, focused on the need for fiscal planning, as well as both the income and expense elements of the profit and loss (income and expense) statement. Today, we will look at net income–which is the total after subtracting expenses from income in any given period–and, yes, it is possible to have a negative number. Net income helps us determine our net worth over any given period of time.
If net income is negative, then we basically spend more then we make. If we spend more then we earn, that negative savings has to be financed, which is to say we have to borrow from our cousin Peter, so Paul (us) can spend what we have not earned in income today. The important rule to remember: when we choose to take on debt to experience a lifestyle, or a sense of worth, outside of what our earnings allow us to afford, there is no such thing as a free lunch. (We will talk more about debt as it relates to the balance sheet and our net worth and its relationship to value in later posts.) Suffice it to say that if you spend more then you make, the problem will be how to borrow from tomorrow (i.e. bring future income forward) to live a lifestyle you cannot afford today with your current level of income. Negative net income or net loss happens in the short run, because the future is unpredictable; the unexpected is never expected, but can be mitigated with planning that allows us to adjust our spending pattens to fit our circumstances.
A short term deficit can be financed, without having to borrow from the savings of another (AKA debt). One can borrow from one’s own savings that is accumulated from operating your budget (i.e. profit/loss) at a surplus over the long run, or better said as: living within your means. Then, if fate has it that you must expense today over and above what your current income can provide, than your previous surplus income (or savings) can fill the gap until things return to normal, and they always return to a degree of normal (or mean) over the intermediate term. Also, if you run a surplus (i.e. income > expense) than your consistently positive net income (or savings) allows you to seize upon opportunities that others, who on average spend more then they make, cannot. If you lack savings then a shortfall has to be met with borrowing, which for many can be the beginning of a debt cycle that leaves one trapped by their circumstances and thus, less free because of them.
Adjusting our net income requires us to consistently look at what we earn (income) versus what we spend (expenses). We have to be willing to look at what we want versus what we need on a daily basis and know the difference. We have to seek value both in what we do for a living and what we consume while living, and try to consistently reach a state of equilibrium where income equals, or is greater then expenses–allowing saving for a rainy day to be established.
In summary, over the course of one’s working life, there will be times when you will need to spend more then you make (i.e. negative net income/deficit/loss), but if you make that an exception to the rule of living within your means (i.e. net positive income/surplus/savings) then you will be more prepared for the always uncertain future and ready to seize upon opportunities that grow your net worth, which is the topic of our next conversation.
Here are other installments in the ongoing Prudent Fiscal Planning Series:
Part 1: Prudent Fiscal Planning is Essential in Todays Economical Turbulent World
Part 2: Prudent Fiscal Planning: Incomes Importance in Fiscal Planning and Its Effect on Our Standard of Living
Part 3: Prudent Fiscal Planning: You Can’t Always Get What You Want
Part 5: Prudent Fiscal Planning: What I Am Worth
Part 6: Prudent Fiscal Planning: What I Really Own
Art Baird, a former high school teacher-whose academic work is in business and economics-continues to study economic and financial theory, as well as micro and macro economic/finance issues of the day, when not playing his role as one founding partner in Creative Marbles Consultancy. You can contact Art at firstname.lastname@example.org or, read his short biography.
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