What is Cash Flow Quadrant? Why does your source of income matter?
Do you find yourself working increasingly long hours with little to show for it, or do you find it difficult to save enough after paying all your bills? Robert Kiyosaki, the author of the best-selling book ‘Rich Dad Poor Dad’, discusses how anyone may achieve financial independence as a business owner or investor by moving to the opposite side of the Cash Flow Quadrant.
The Cash Flow Quadrant is one of Robert Kiyosaki’s great concepts. In his famous book named Rich Dad’s CASHFLOW Quadrant: A Guide to Financial Freedom, Robert Kiyosaki presents a thought-provoking idea in the financial space. He frames a tabular framework to show four approaches to building wealth.
This concept entails the various career paths that a professional takes and their respective tax structure. It explains how various professionals visualize the world.
The Four quadrants
The Cash Flow Quadrant is divided into four areas. These are:
Four quadrants – E, S, B, and I
The concept believes that there are four types of people that exist in the working world and each quadrant represents a different way to generate income.
‘E’ stands for Employee, ‘S’ stands for self-employed, ‘B’ stands for Business Owner, and ‘I’ stands for Investor
E and S are on the left side, which represents active income
B and I are on the right side, which represents passive income
Before diving into which quadrant can contribute best to your financial freedom, let’s first see what each means:
The left side of the Cash Flow Quadrant
It depicts active income, i.e., a person is trading time for money. He or she needs to perform something to generate money and every day starts from zero.
‘E’ for Employee:
An employee values security above all else and seeks the safety of a long-term contractual agreement.
The characteristics of this quadrant are as follows:
- Most individuals work in this area.
- Here, you work for a company and trade your time for money.
- To earn more money, one must work more hours OR work for another company that compensates better.
- If you don’t work, you don’t earn any money.
- People falling under this category give their time, energy, and skills to an employer in exchange for a pay check.
- Your earnings will always be capped, no matter how hard you work.
‘S’ for self-employed:
A self-employed individual does not want their income to be dependent on other people. They essentially own their job and are likely to be perfectionists who value independence and expertise.
The characteristics of this quadrant are as follows:
- The people falling under this category are often considered better than an employee.
- They get more personal and financial freedom than an employee. However, one is still trading time for money.
- In reality, you don’t own a business rather the business owns you.
- Dentists, insurance agents, practicing lawyers, CAs, architects, etc. are some examples.
- Here, they do have a lot more control than an employee, but that also means they have more responsibility.
The right side of the Cash Flow Quadrant
It depicts passive income, i.e., a person does not have to be present to generate passive income. Sources of such income can be real estate, stocks, bonds, etc. It is often called making money while sleeping.
‘B’ for Business Owner:
Business owners own a system or a product that makes money even when they aren’t working. Because they recognize that they cannot be successful on their own, business owners seek to hire people who specialize in skills required for the business as well as those who have more talent and skill than them. They try to delegate as much as possible rather than doing everything by themselves.
The characteristics of this quadrant are as follows:
- You have a system in place and other people are working for you as employees.
- You are selling a product or a service.
- People falling under this category lead other people.
- Here, one is not trading their own time for money.
- You don’t have to be working for the business to generate income.
- These people have the benefits of writing off business expenses out of business profits and taking advantage of favourable changes in the economy.
- Business owners are often seen as risk-takers.
‘I’ for Investor:
Investors have the highest financial education of anyone in the Cash Flow Quadrant.
They are skilled at identifying assets that generate steady income in the form of cash flow. They then use income from those assets to acquire even more assets, growing their wealth through this velocity of money. They benefit the most from tax breaks, don’t have to work at all if they don’t want to, and don’t have to deal with employee management. The wealthiest people in the world are investors, and as a general assumption, 70 percent of their income comes from investments, with the remaining 30 percent coming from wages.
The characteristics of this quadrant are as follows:
- This is called true passive income.
- People falling under this category are at the highest level of financial security.
- Investments in shares, bonds, real estate or trademarks, copyrights, and royalties generate an annual cash flow.
- You build them once and have a long time span (5 to 10 years) in pay-outs.
- Such an income allows you to retire.
- The goal of investors is to stop working altogether and to live off the income from their investments (like Warren Buffett).
Interpretation – What should be your approach?
Theoretically speaking, one could be located in all quadrants, but most people are not.
Each one of us fits into one of the four quadrants and it’s important over time to have a plan to get from where you are to where you want to be in the quadrant that’s right for you.
Right or wrong, the tax system is designed to favour large businesses (B) and investors (I). Many highly paid salaried employees get to pay huge taxes under the country’s tax system. You get lower tax rates typically in the ‘B’ and ‘I’ quadrants.
Tax rates on domestic companies are 25-30% (25% for turnover up to Rs. 400Cr) plus applicable cess and surcharge. As compared to this, salaried individuals or professionals are being levied taxes following their slab rates based on the income bracket they fall into.
Moreover, a person is eligible for far more tax write-offs/deductions as a business owner than those available to individuals.
The list of personal deductions available to individuals can be unreimbursed employee expenses, mortgage interest, student loan interest, etc.
On the other hand, the list of deductions on business income may be concerning capital gains of a corporate entity, interest income, depreciation, carry forward and set off of losses, expenditure incurred by a company for setting up of a business, or for an extension, preliminary expenses made before the establishment of the enterprise, tax incentives to encourage businesses to venture into certain sectors, contributions to a political party or electoral trust, etc.
As per Robert Kiyosaki, the goal should be to get into these two quadrants (‘B’ and ‘I’) as much as possible. In other words, the goal must be to progress through the table and become more on the right side of the table. This allows people to work less, earn more and pay less in taxes, and become financially secure. The more you leave the crutches of a secure financial environment be it a job or self-employment, the more financially independent you become. But this is not a one-day achievement. It takes tonnes of planning, risk-taking, and embracing a long-term vision in your outlook to reach up to that level. The majority of Kiyosaki’s book teaches the unique skills and mindsets required to succeed on this path. These are the primary paths to financial freedom.
To move to ‘B’ and ‘I’ quadrants, one needs to create a system so that others can perform the primary functions of their business, that way they have the freedom and flexibility to do other things be it planning for investments, a holiday, or a business expansion.
I would recommend reading his book for better insights :)
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