What ‘financially fit’ means
Question: What does it mean to be financially fit? Does this mean I should have zero debt and lots of cash or investments?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook.
Answer: I was given an opportunity to conduct a personal finance training for utility personnel of a school many years ago. All of the participants in that training were struggling with money. Well, all except one. Let’s call the exception Mr. Johnny.
Why was Mr. Johnny the exception? He started his career as a utility person. His whole life, he was a utility person. And he retired as a utility person. Yet, among the utility personnel at the training, he was the only one who was able to send two children to college, own a car, own a house and have a business run by his wife. When I asked him how he was able to manage all of these things, he replied that he followed the three “P’s”.
In Pilipino, the three “P’s” mean “pala-save, pala-invest and pala-utang ng tama.” He saved, invested and borrowed appropriately. He knew he had a small income but he forced himself to save whatever he could. He was responsible with whatever borrowings he contracted.
He later used his savings to buy pieces of land in his home province. Back then, land prices were low but as the economy grew, so did the value of his land. He sold them at higher prices.
Without going through training, Mr. Johnny was already doing what taipans were doing in running their empires. In his own way, he was as financially fit as the rich.
What Mr. Johnny applied is called the Du Pont Model. Under this, a company would have a high return on equity if it had a high level of profitability as evidenced by high net income margin (net income divided by gross revenue), re-invested savings in earning assets as evidenced by high asset turnover (gross revenue divided by total assets) and contracted debt to buy earning assets as evidenced by high equity multiplier (total assets divided by equity).
Having too much cash is not good if it will only be kept in low-earning savings accounts and in amounts beyond the required level of emergency funds. Debt in itself is not bad provided it is used to buy earning assets.
Being financially fit can be equated to having a high return on equity, which one saves a lot, has a greater portion of his assets as earning assets and has debt to fund purchase of more earning assets.
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