Pop quiz: When you put $100 on your credit card because you don’t have the money to pay cash now, how much income do you need to earn to pay this back?
c) more than $1000
The answer is (b), and possibly (c). Why?
First, you put the amount on your credit card, because you don’t have the cash. So the cash to pay it back has to come from future earned income.
Next, assuming your other basic expenses (food, rent, car, insurance, etc) stay the same and can’t be cut back, so the amount to be reimbursed needs to come from the difference between your income and your expenses for the month (assuming there is a positive difference at the end of the month). So let’s say you have a 10% surplus at the end of the next month. This is optimistic, but let’s postulate this.
So the income needed to pay off the $100 in credit card debt then comes from the following:
income needed = the debt (divided by) surplus income percentage
$100 / 10% = $1000 is the income needed to pay off the principal
Plus the 12% credit card interest rate (if you’re lucky)
The big mistake that most people make is that when they put something on credit, they assume that they can pay it back from future gross income. But when there is nothing left from that next paycheck, the amount rolls over to the next month, the next and the next, and eventually grows (because other charges add to the card) and becomes too big to pay back.
Salaried employees are stuck because the only way they can generate a surplus on their income is by cutting back expenses, because their income is fixed. Because people are not conscious of the true high price of debt, which is the ability to pay it back, they have been digging themselves deeper and deeper into a hole which is impossible for them to climb out of.
As solos we have an ability that wage-earners lack, that of being able to adjust our income upward to quickly absorb debt and pay it off. Which means first we need to have surplus income, and second, the ability to increase it by getting more clients more efficiently.
Failure to understand the simple math of debt is why the economy is tanking. And this is the mistake I made with my first business. I started putting business expenses on my cards, expecting to pay the balance with the income generated by new clients. But I didn’t realize that the reason I was putting expenses on cards is that I did not have surplus income, so there was no way I could ever pay back the principal. And I eventually had to play the bankruptcy card to get out of a six-figure debt. Luckily I learnt my lesson and am much smarter about debt now because I know the million-dollar question: how does this expense increase my income so it pays for itself?
This means that every time you whip out that Visa or Mastercard, ask yourself: “How many more clients do I need to get, above and beyond what I currently have, to pay off this debt?”
As a business person I want to minimize my liabilities (money goes out) and maximize my assets (money comes in). For every expense, I want to make sure that it doesn’t just pay off the principal, but it also generates its own income, a “return on investment” (ROI).
ROI = (income generated by the investment) / (cost of the investment)
And I aim for at least a 100% ROI for every expense: that it not only pays for itself but also generates an additional amount equivalent to its cost. So for that $100 debt, what I really need is to be able to generate $2000 additional income. That expense better help me to generate that increase in income!
So please, please, please shop smart this holiday season. Don’t dig yourself so deep in debt buying that you compromise the stability and prosperity of your business in the New Year. Don’t burden yourself with liabilities, instead, start accumulating assets.
The more you focus on ROI each time you spend, the smarter you will shop and the more profitable you will be.