It is important for everyone to understand the basics of personal finance and to use them effectively as well.

Any individual has two types of income. Assured income as well as non-insured income.

Insured income is income that will keep flowing whether you are personally working or not. For example, rents, dividends, royalties, interest, etc.

Unsecured income, on the other hand, is income that stops flowing the moment you stop working. For example, paycheck, bonuses, etc.

Similarly, there are broadly two types of expenses: fixed and discretionary. Fixed expenses such as taxes, debts, insurance, household expenses, etc.

To achieve “personal financial freedom” we must concern ourselves with a Flow, which we can call the flow of freedom. This is the difference between the Total Expenses and the Assured Income, if the result is negative, then it smells like freedom. On the other hand, if the result is positive, it implies continuing to be trapped in the debt trap.

There is a simple formula by which you can determine how long it would take a person to achieve “personal financial freedom.”

N = Freedom Flow / AIOP x recovery

Where, N = Number of years needed to reach the threshold of freedom.

Freedom Flow = Total Expenses – Insured Income

AIOP = Insured income that can be generated as a percentage of the restart. A 10% conversion is a good reference.

Plow back = (total income) – (total expenses). This is the money available for conversion to guaranteed income.

To take an example, if for a person,

Secured rent = $25,000

Total income = $1,00,000

Total Expenses = $85,000

AIOP = 10%

So the reset is $40,000.

So, as things stand, the number of years needed to reach the threshold would be:

60,000 / 0.1x 40,000 = 15 Years.

Now, let’s say the person can reduce their total expenses by 20% and improve their AIOP by 15%, then the number of years needed for them to reach the threshold would be:

43,000/.15 x 57,000 = 5 years.

Such is the power of this equation, that it essentially means that we must

Keep the freedom flow as low as possible. Increase income and reduce expenses.

Maximize AIOP

Maximize the plow back.

This formula, however, does not take inflation into account. It’s better to use this as an indicative tool rather than dissect it for precision.