How to Simply Avoid Debt Using this Equation?

May 12, 2010 by Victorino
Filed under Debt Management

Avoid debt now! If you haven’t avoided it yet, the earliest period to start is NOW! In my previous article entitled “the secret formula to get out of debt”, I have revealed how a simple accounting equation will help us get out of our debts. In this article, we will tackle further this formula and learn how to simply apply it to avoid having debts. Of course, our goal to eradicate our liabilities and obligations require a lot of great debt management principles and attitudes. Great as I say, yet they are basic and simple. This is the essence of fundamentalism – finding solutions between the roots. To simply avoid debt, let’s go back to the following equation:

Assets = Liabilities + Equity

As we transform this to,

Liabilities = Assets – Equity

As we understand, personal assets and equity are,

Equity = Paid-up capital + Cumulative Net Income (losses)

And since,

Net Income (loss) = Income – Expenses

Therefore we can say that,

Liabilities = Assets – [Paid-up capital + (Cumulative income – cumulative expenses)]

And in our personal parlance, considering a one year equation, assets as properties, paid-up capital as zero, and expenses as our wants and needs, this equation can be transformed as,

Debt = Property – Income + Wants

If today we have the following:

Debt = $1,000

Property = $1,500

Income = $2,500

Wants = $2,000

As we place these values on the equation, we will arrive to this:

Debt = Property – Income + Wants

$1,000 = $1,500 – $2,500 + $2,000

Now if we want to make our debt of $1,000 to zero, we can opt one or all of the following ways:

a.) Sale a property amounted to $1,000 and pay-off our debt amounted to $1,000

Upon sale of property at book value amounted to $1,000,

($1,000 – $1,000) = ($1,500 – $1,000) – $2,500 + $2,000

We can pay extinguish our debt.

$0 = $500 – $2,500 + $2,000

This application is simple. If we want to get rid of our debts, we may sell some of our properties and use their proceeds to pay-off our debts. But we must also remember not to sell assets that are generating substantial revenue for us. This means, we must analyze first the best decision – whether to benefit from an asset through its proceeds or through its generated income. This is because generated income can also be used to pay-off our debts.

b.) Earn additional income of $1,000 without selling your property (this can be done through rendering of services), and use the additional income of $1,000 to pay-off all debts

By earning an additional of $1,000,

($1,000 – $1,000) = $1,500 – ($2,500 + $1,000) + $2,000

We can eradicate our debt.

$0 = $1,500 – $3,500 + $2,000

Another way to eradicate debt is to earn more and more income. This means we need to be diligent and innovative to do that. But we should also bear in our minds that big income is useless if we also have huge expenses. Hence, we should also have the virtue of self-control and discipline. To increase our income we need to work harder, longer and wiser. The people who usually incur debts are those who don’t earn enough money to cover their expenses or repay their obligations.

c.) Reduce our wants (expenses) by $1,000

By reducing our expenses by $1,000,

($1,000 -$1,000) = $1,500 – $2,500 + ($2,000 – $1,000)

We can reduce our debt to zero.

$0 = $1,500 – $2,500 + $1,000

Spending more than you can afford is one of the top reason why people are trapped into debts. In the equation, it is very clear that if we will cut our expenses, we can also cut our debts. Since our expenses are originated from our needs and wants, we should know how to prioritize things. This can be done, by spending based on our needs instead on our wants.

I hope this simple article will help you win your battle against debt. Always remember that financial freedom is the ability of a person to harmonize all the financial elements around us, which include our assets, equity, income, expenses and debt itself.