The secret formula to get out of debt

May 3, 2010 by Victorino
Filed under Debt Management

What is the real secret formula to get out of debt? Actually there is no secret formula to be free from your creditors. There are just some basic financial formulas. But because most people often forget the basic things, those formulas were putted into oblivion. They are ignored and become secrets to people who subsequently become unaware of them. Now let’s uncover again these secret formulas to successfully overcome our debts.

Knowing is good, but understanding is better. That’s why, let’s not just memorize the following formula but let’s understand it. The following formula and explanations are derived from the financial accounting equation, Asset = Liability + Equity.

Liability = Asset – Equity

The above equation gives us the understanding of the following:

1. Increase in asset without increase in equity will increase your liability
This means that if you obtain cash or acquire properties and other assets without accumulated earnings, you will resort into debts. The debt trap is usually found behind our needs and wants. Once we desire for something we cannot afford to pay for cash, we call the lenders and the creditors for help. Therefore to prevent debt, we should not buy something beyond our earning.

Don’t increase your asset if your equity cannot afford that increase.

2. Decrease in asset may reduce your liability
One certain way to decrease or extinguish your debt is to pay-off them. If you have cash to settle your obligations, then settle your debts. If you have receivables, then exert your best effort to collect them so that you can use them to pay your own liabilities. If you have assets that don’t generate income, you may sell them and use the proceeds to repay your debts.

Cut your asset and use that to cut your debt.

3. Decrease in equity without increase in asset will increase your liability
Equity is equal to infused capital plus accumulated earnings (losses) minus capital drawings or dividends. This primarily means that if you incur losses or don’t earn enough profits, your chance of getting out of debt will fade. Net income or profit is directly related to your revenue and inversely related to your costs and expenses. Moreover, revenue is directly related to your assets such as cash and receivables while your cost, purchases and expenses are directly related to your liabilities such as accounts payable and accrued expenses. Hence, to decrease or zero out your liability, you should increase your revenue to collect more cash and receivables and efficiently minimize your cost and expenses to avoid more trade payables and unpaid expenses.

Increase your equity to prevent increase of your liability.

4. Increase in equity may reduce your liability
As discussed in the preceding paragraph, increase in your cumulative earnings will increase equity. If your equity increases, you can be able to finance your needs not by means of debts but by means of the assets generated from your revenue, such as cash and receivables generated from your sales. Therefore, strive for earnings to increase equity and to get out of debt. Work well to increase your salary income. Do business well to increase your business income. Also, avoid unnecessary costs and expenses to avoid losses that will result to deficiencies in your equity.

Conclusion and the real secret formula:
The secret formula to get out of debt is simply you. You, being the one who is capable of knowing and understanding the basic formulas (e.g., accounting equation, financial ratios, etc.,) that the world has provided us. You, being the one who can control your effort in accumulating profits. You, being the one who can manage your behavior in spending your money. And you, being the one who can only defeat the poor person within you.