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From a financial hole to financial freedom

Each of us must clearly understand where we stand in terms of our financial situation. Here are four basic financial states:

#1: Financial “hole”
This is the worst financial state, when expenses exceed revenues, resulting in the presence of debts and the complete absence of any reserves and savings.

The biggest mistake that is often made in this case is taking out new loans – loans to pay current payments. Thus, the financial hole is digging even deeper.

The only way to get out of the financial pit is a very tough and total control of finances: systematic reduction of spending and a real plan for increasing revenues.

Revenues (active)< Expenses
V  Debts
X  Savings
#2: Financial instability
State in which budget revenues from all sources (most often 1 active source – current work) are equal to or approximately equal to all current expenses. Being in a state of financial instability, a person, simply put, spends as much as they earn, and has no reserves or savings.

Financial instability is a very precarious state in which there is enough income to live, to make all payments, purchases, and even for entertainment or a vacation. But the loss of this single source of income, illness, or accident instantly leads to debts and a transition to the previous state – a financial pit!

Revenues (active) = Expenses
V Debts
X Savings
#3: Financial Stability
This is a state in which the active income of a person exceeds all current, expenses. In this state, as a rule, there are no debts. Instead there are savings that represent the financial cushion and allow to easily survive all kinds of unforeseen situations (for example, loss of income). In addition, the excess of income over expenditure makes it possible to constantly increase savings, create capital.

Speaking of income, the majority of financially stable people, as well as people in the state of financial instability, usually have an active income – wages that depend on their activity (for example, salary).

However, in a state of financial stability there is opportunity to create passive income that does not depend on the results of active labor (for example, interest on deposits, rental income, etc.

Revenues (active) > Expenses
X  Debts
V  Savings
#4: Financial Independence
This is a condition everyone wants to get in. It’s also called financial freedom complete independence of money: income from many different sources significantly exceeds the expenses. In addition to savings, there is capital, which brings the main income.

A financially independent person does not need to actively earn income. They can continue working – if desired, for their own pleasure, and not for the sake of money.

Revenues (active)>> Expenses
X  Debts
V Savings + Capital

In North America, it is considered quite acceptable to “live in debt”. However, upon careful consideration, any debts – from bank loans to personal loans to debts to pay bills – have a very negative impact on one’s financial health. Since the use of borrowed funds often involves additional costs (interest fines for late payments, etc.).

Note that an owned property, a car and other material possessions cannot be considered as positive indicators of financial health – if they are acquired for personal consumption, purchased on credit, and the debt hasn’t yet been fully repaid.

Therefore, to improve your financial health, you should strive to increase your income (so it substantially exceeds your expenses), and consider loans last, and only with the aim of raising the revenue (and not expenditure!) part of the personal budget. Stay financially healthy!

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