Do Yourself a Favour: Master The Accounting Basics, And You Are Done! [A = L + E ]

A = L + E

And similar to pretty much any equation, you can maximise this one too.

--> That is Max (A) = Max (L + E)

In particular Max (L + E) means finding the best equilibrium between L and E.

Are you wondering what does A, L and E mean? Easy, A is your Assets, L your Liabilities and E is your Equity.

Ask an accountant what "A = L + E" is. He will look at you differently, he will admire you.

Try to see your life as a business. Life events can be broken down into events that are comparable (financially) to a business.

You buy a House (A) which you finance a little bit with your own cash savings (E), namely the upfront deposit, and the rest with a mortgage (L).

Then how Max (L+E) is achieved in practice? It means maximising your A by using E and L optimally.

If you believe that the house that you will buy will appreciate in value faster than the cost of debt (i.e. interest rate that you pay on the mortgage), then try to use more L (the money that the bank lends you), so that when you will pay your last mortgage payment, your return on the investment will be much higher than having used less L (i.e. having asked for a lower amount of money from your bank).

This is called leverage in finance, and it makes sense to use it. At least up to a certain point, but this is not the point of this teaching.

Finding the right E and L combination is basically meeting the condition “Max(L + E)”.

But this is more an art than a perfect science. However, if you try to make an effort to learn this art, it will force your mind to think like an accountant, and believe me, accountants are wealthy.

You see, the 3 components are strictly interconnected.

Suppose you do not have any sport car (L) and have only cash (A).

In this case your A will be equal to E.

Why? Simple, since L = 0 then:

A = E

But... if you decide to buy the sport Car (L), then you will use all your cash (E) which will drop to zero and all of the A will be the car itself (L). In equation terms: A = L.

Therefore by buying the sport car your Assets will become Liabilities entirely. Which I think is bad. Very bad.

Well at this point if you do not agree with the fact that the sport car is a Liability look at what it gives you and what you have to give to it in order for it to give you what you want.

Puzzled. Read again.

You need insurance, maintenance, parking, garage, tyres, fuel, etc.

All of these items will be a drag on the cash sitting in your bank account (which, if you do not budget well, will not be for long) and give you nothing back but a bit of freedom. Are you willing to pay this price? Think twice.

Look, what truly matters is to understand that a car itself might not be necessarily a Liability. If your car is a necessary "money making tool" that increases your wealth, then your car is an Asset.

However if you are picky and want the last Mercedes model to go to the same job that you could easily go to with a cheaper Fiat 500, then the extra price that you pay for a Mercedes is a Liability, without considering all the extra expenses that owning a Mercedes entail.

The point is that if you decide to buy a Mercedes you will become poorer faster, or conversely you will become richer at a slower rate (even though the Mercedes is faster than a Fiat 500).

Think twice before buying stuff you do not need. Master the wealth equation and enjoy the ride to new highs.