The difference between active and passive income sources

There has been a long-lasting debate in society about whether to get a job and stay safe or to get out of the safe zone and do your own business. However, the ultimate decision depends on the nature of risks that a person is willing to expose. If you are a risk-averse person: you will do the same work till you die or retire. Otherwise, you will either end up owning one or more successful companies, which will eventually be passing doing to your generations, or you may end up broke (due to mismanagement of funds and finances).

In both scenarios above, you will have to be a participant in the game. If you sat down and wait till the gameplay itself, you will either have to find another job or again you will end up broke (obviously, if you don’t do your own business, you won’t generate cash).

Although there is an equal number of debates going on about the passive income sources, there has been no proper rule on segregating, which is active and which is passive. I will explain the meaning of active and passive income sources and will also refer to the best selling book “Rich dad Poor dad” examples on these income sources.

As I explained earlier, business and job is obviously an active income source as you have to “actively” participate in the game in order to enjoy profits or salaries and bonuses. In passive income sources, you will not work a single day to gain profits, neither you will get salaries. Instead, the money will work for you and will bring you profits and interests.

“Don’t work for money, make it work for you” – Robert Kiyosaki.

How does this work?

As per researches, it has been noted that one of the most boring subjects in the world is “Accounting.” However, accounting is the key to a fortune.

According to accounting fundamentals, there are two types of statements where a company or a person can apply to their transactions.

  1. Statement of Profit or loss – where all the transactions records
  2. Statement of financial position – where all the final balances showcases (assets and liabilities)

Let’s answer the question now; assume you maintain an accounting system for your transaction. In the given nature, your income and expenses will be recorded in the Statement of Profit or loss, and resulting balances will reflect in the Statement of financial position. In order to understand the true nature of assets and liabilities, let’s take two distinct transactions.

  1. Asset – Assume you receive your paycheck, and you started saving money out of the paycheck; as time passes by, your savings will start increasing, and you will start receiving interest on it. Accordingly, the assets side of your balance sheet will increase, and as a result, your Profit or loss will get a positive impact.
  2. Liability – Assume you acquired a car on a leasing arrangement. You will start paying interest on top of your actual capital repayment. As a result, your liabilities side of the balance sheet will increase, and hence your expenses will increase and eat up your profits.

In both contexts, you think you acquired assets (savings and a car). However, the second sentence of each example shows the consequences of acquiring liabilities and assets. It seems both are the same; however, in essence, it’s different.

“Rich people acquire assets. The poor and middle class acquire liabilities that they think are assets” – Robert Kiyosaki.

Accordingly, it is advised that the Balance sheet must be then asset-rich instead of liability rich.

I will bring more content in the future on increasing passive income sources as part of your job or your business as a personal finance plan.

“Hoping drains your energy. Action increases your energy.”

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