There are essentially three ways you can make or earn money:
- Income from employment
- Income from a business
- Income from investments/assets
Employment income: The income you earn by being employed is payment for your time, skills or expertise. It’s an exchange – someone else’s money for your time and input into their business. As an employee you may take an hourly wage, an annual salary or by piecework which is where you get a set price per unit or job finished. This is dependent on the sector you’re in or the type of work you do.
Business income: The income you earn from setting up and running a business of your own, whether you’re a one-woman band, employ freelancers or have a team of fully employed staff.
Asset/Investment income: The income you receive from investments or assets you own. This includes but is not limited to (i) rental income from investment property; (ii) income from your retirement fund (e.g., pensions); (iii) dividends and interest; and (iv) royalties.
This categorisation is aligned with the CashFlow Quadrant in the book ‘Rich Dad Poor Dad’, by Robert Kiyosaki. Have you ever read the book? It was first published 1997 and has really stood the test of time. For me it was one of the first personal finance books I ever read.
Robert Kiyosaki’s CashFlow Quadrant identifies the four main sources of income:
E = employment income
S = self-employment income
B = business income
I = investment income
So, Robert Kiyosaki has split business income into self-employed income and business income. I’ve merged them – hence only three sources of income. As when you’re self-employed, you are running your own business.
At the time of writing, Robert Kiyosaki referred to business income as being “attributable to large businesses”. And that people who were self-employed were selling their time for money, in a similar way to employed.
But things have changed. Since 1997 the internet has exploded which has completely changed the concept of business, as small businesses, even those run by a solopreneur, can now scale easily and generate a high level of turnover/revenue. Today, I think a more important distinction is the type of business, which I discuss below.
As an employee, you’re creating wealth for the business owners you are employed by. For many people, this is fine; there are many reasons they are happy being an employee. They don’t want the hassle of running their own business and feel like all their needs are taken care of. And they live a comfortable life. They spend their spare time at the beach or doing their favourite hobbies and if they get sick, they still get paid. Many have pension and private healthcare perks and a yearly bonus.
An alternative to being an employee is to become an entrepreneur, but not everyone is cut out for it. For those that are, there are essentially two types of business: (i) lifestyle business; and (ii) legacy business.
A lifestyle business is one which generates income for the owner(s). It’s built for profit. The purpose of the business is to facilitate a particular lifestyle for the owner(s). This doesn’t mean that lifestyle businesses can’t be significant.
Thanks to the internet, some lifestyle businesses can now scale significantly. For example, a coach can now run online group coaching programmes rather than doing one-to-one face-to-face coaching.
Lifestyle businesses tend to be focused on one or more key persons, without whom the business would not be able to continue. The owner(s) personality is key, as its customers will be those who resonate with the owner and appreciate her being authentic.
In a lifestyle business, the owners take profit out of the business as income. They don’t really invest in the business. Although the business can pay for a lot of ‘perks’ such as training, car purchase or lease, or other expenses which are a personal benefit to the owner.
The thing about a lifestyle business is that there may not be anything (or very little) to sell when the owners decide to exit the business. This is because when you take the owner out of the business, there usually isn’t a business anymore. There have been instances of owners selling their lifestyle businesses for large sums of money. But this is the exception, not the rule.
A legacy business (also referred to as a scalable business) has the potential to move beyond its founders. It’s built for growth. It increases in value over time as the owners continue to invest in it. The owners can also take profit out of the business as income, but this is usually kept to a minimum. Instead, most of the profit is ploughed back into the business. Hence, the owners defer their pay-out into the future.
A legacy business will usually have a management team. The business is not dependent on the owners. The business can serve as a legacy that the owners leave to their family or employees or be sold to an outside buyer.
There are examples of businesses changing from a lifestyle business to a legacy business. But this requires some major changes. And isn’t common.
This is income from income-generating assets, such as property, equities (stocks and shares), retirement income and royalties. These are assets that you either create or purchase.
Mixing it up
Of course, you can bring in all three types of income. You can have a 9 – 5 job as an employee, run a small business as a side hustle, and invest in income-generating assets.
It’s up to you to decide how you want to make your money. After all, it’s your life, so it’s also your way.