Regardless if you’re an employee or a business owner you want to keep improving your financial IQ.
Of all the books I’ve read over the years, few have done more to boost my financial IQ than Robert Kiyosaki’s “Rich Dad, Poor Dad” and “Cash Flow Quadrant.”
“Rich Dad, Poor Dad” is a powerful introduction to money and finances; it will increase anyone’s financial intelligence. The book offers some unique insights, including:
- The rich don’t work for money… they make money work for them.
- The rich invent money… they understand how to use debt, taxes, and leverage.
- The rich buy assets, not liabilities… they understand the difference between an asset and a liability.
- The importance of acquiring a financial education… our schools don’t teach money or business.
“Rich Dad, Poor Dad” has been one of the most successful financial books of all times! I think everyone should read it, and it’s a must-read for anyone running a business.
But now, let’s talk about the ‘Cash Flow Quadrant.” It’s another amazing book by Robert Kiyosaki, who has a real knack for breaking down complex concepts so they’ll become easy to understand.
So what is cash flow and why is it so important?
What is Cash Flow?
Even though we tend to associate cash flow with business, all of us deal with cash flow every day; we just don’t think of it like that.
Almost every adult has:
- Money coming in (income) either from a paycheck, business, investments, or from another source
- Money going out to pay for ongoing or one-time expenses, such as rent, mortgage, utilities, a vacation, etc
That’s cash flow! The challenge is to manage your cash flow, so you have more money coming in than going out.
Well, the same is true for business.
Money is moving in and out of the business every day of the month.
- The business takes in payments from customers or patients for products or services it provides to them.
- The business then pays out money for the expenses it has such as rent, utilities, loan repayment, employees, and more.
And again, the challenge is to have more money coming into the business than what’s going out. It’s called profit… what’s left over after everything else has been paid!
Why is Cash Flow Important?
If you’re thinking… well, that’s pretty obvious, you’re right.
Cash flow is important because, without it, any and all business activity comes to a screeching halt. When your business runs out of money, you’re in serious trouble.
There’s no money to pay the rent, the lights, the phone, not to mention your employees or your taxes! And without the cash to pay the bills the business eventually has to fold.
Now let’s get back to Kiyosaki’s “Cash Flow Quadrant” and see how it relates to our discussion.
One of the core concepts in his book is that money “flows” differently depending on how income is earned. He distinguishes two types of income:
- Active income, you’re actively working for your money
- Passive income, your money and other people’s money are working for you
Kiyosaki describes four distinct categories of generating income, hence the cash flow quadrant. The categories are:
- Self Employed
- Business Owner
Aside from inheriting money or winning the lottery, we all generate income if one or more of these four categories:
So what’s the big deal with this? Well, here’s the interesting thing…
The quadrant you’re operating from determines far more than just your income and how much you’ll pay in taxes.
- It determines how you think, the words you use, what actions you do or do not take.
- Frequently it determines if you invest your money in an asset or liability.
- It determines your financial position and ultimately how you operate in the world.
But before I go on, let me emphasize there is no right or wrong quadrant; because there’s no right or wrong answer. What works for you and makes you happy is what matters!
However, most of us operate in one quadrant by default, because we’ve never learned what else is out there. And I think that’s a shame. How can you make a good choice, when you don’t know what’s on the menu?
So now let’s take a closer look at the four sections of the cash flow quadrant and how they tend to play out.
Employees earn their money by working a job; they trade their time for a paycheck. Income generated in this quadrant is active income.
While employees may enjoy a great degree of flexibility in how they work, ultimately it’s the boss who has the final say about how things are done.
Regardless if employees earn minimum wage or millions of dollars, they are not in charge of their earning power. The amount of money an employee earns is dictated by external forces.
Thinking and Words:
Typically, employees want a safe, secure job. They are looking for a good wage and generous benefits. They are afraid of losing their job.
Most dislike debt and taking on risk, and they tend to avoid both.
Often they use words like
- I want a safe, secure job
- I need a raise
- I need a higher paying job
- I’m looking for a safe investment
Depending on the tax bracket and individual situation, employees may pay up to 40% in taxes. Employees tend to pay the second highest taxes of all four groups. Often their house is their biggest investment and viewed as an asset.
The self-employed don’t have a formal job; they own their job! Generally, income generated in this quadrant is active income.
- They are attorneys, accountants, nurse practitioners, and other professionals in their own
- They are the small business owners who deliver the actual work.
- They are the high-income individuals like clinicians, consultants or performers working on a contract basis.
- Most of the self-employed business owners can’t be away from the office without losing income.
Thinking and words:
Many small business owners work alone and like it that way. Often they are convinced they’re the only ones who can do the work and do it best.
That’s why the self-employed often say things like:
- I just can’t find anyone to do this
- I’m the one who does it best
- If you want it done right, you have to do it yourself
- It’s easier just to do it myself than to explain it to someone
People in this group on average pay the most in taxes. Some self-employed can pay up to 60% in combined taxes, depending on how the business is organized and on the unique circumstances.
That’s a lot of taxes over a lifetime!
Business Owner (Big Business)
Just like the self-employed, these people also own their own business. But there is a big difference between the two groups.
While the self-employed work in their business, most business owners don’t do the work themselves. They have employees to do the actual work, and they have managers to oversee what’s being done.
Business owners functioning in this quadrant tend to do high-level activities in their business. They may work on planning, marketing, growing the business and perhaps sales. They work on the business instead of in the business.
Because they’ve put a range of systems in place, they can be away from their business, and the business continues to run. Income generated in this quadrant may be passive, or it might be a combination of active and passive income.
Thinking and words:
Individuals owing bigger businesses tend to be team oriented and value systems. They tend to say things like:
- I need to hire more people.
- I could use another person on my team.
- Who would do a better job than I?
- How can I create a system for that?
Individuals in this quadrant typically pay less, around 20% in taxes.
Professional investors neither operate nor manage a business and of course, they don’t own a job. They put their money into different asset classes and expect a return on their investment. They invest in:
- Real Estate
- Paper Assets
- Commodities (gold, oil, )
Thinking and Words:
Investors are concerned with ROI (return on investment). They are not afraid of risk but pay attention to how they can manage their risk. They will consider insurance to guard against risk.
They’ll use words like:
- Risk and risk management
- Is this a good investment?
Out of the four quadrants, the people in this group frequently pay the lowest in taxes; some don’t pay any taxes whatsoever. And regardless if you think it right or wrong, it’s all 100% legal. Income in this category is passive income.
So now you have a 40,000 ft view of Robert Kiyosaki’s “Cash Flow Quadrant.”
Perhaps it’s time now to ask yourself what quadrant you’re in.
Since you are a Clinician in your own practice, you operate from within in the S quadrant; you’re a self-employed specialist.
And while it seems obvious, it’s not always as clear-cut as it seems. Because often we operate in one quadrant but bring to it the mindset of another quadrant.
For example, you may be operating from the S quadrant but still cling on to the mindset of the employee looking for safety and security where there is none.
Most people start out and stay in the E, the employee quadrant. From there, a percentage moves on to the S quadrant by starting their business and become self-employed.
Fewer still move on the B quadrant and even less transition to the I quadrant. Just as employees are more likely to move on to become self-employed, owners of big businesses are more likely to become investors.
Why Should Any of this Matter to You?
There are times you realize that you’re not exactly where you want to be. You don’t know what you should have done differently; after all, you did as taught.
You went to school, got good grades, and got a job. And some even ventured out on their own.
By tapping into the framework of the cash flow quadrant you now have a deeper understanding of business and your options. And even though you may have no or little interest in moving to the B or the I quadrant you can start asking questions:
- What words do I use when I talk about my business?
- Do I use the language of a different quadrant?
- Do I think like an employee or a business owner?
- How can I structure my small business more like a big business?
- How can I implement more systems and make better hiring decisions? How can I get help in certain areas of my business?
- How can you reduce my current tax liability and keep more of my money without moving to another quadrant?
- How can you think more like someone in the B or the I quadrant, without switching quadrants?
Here’s is the thing…
Always keep learning about business and finances. Keep working to develop your business skills. Never stop improving your financial IQ!
Both of the books hand you a first class financial education. Actually, it’s business and financial education at its best!
Let us hear from you. Tell us what you think by leaving a comment below!
By Johanna Hofmann, MBA, LAc; regular contributor to the NPBusiness blog.