This month we read - The Goal: A Process of Ongoing Improvement By Eliyahu M. Goldratt. The Goal is about global principles of manufacturing, which at first may sound really really boring, however Goldratt writes the book as a novel. In The Goal he tells the story of a Plant Manager who is on the brink of losing his job, and having his plant shutdown if improvements are not made in the next 3 months. Oh not only that, but his marriage seems to be on the same time line! Oh The Drama! Throughout the book the main character, Mr. Rogo, uses the people and things around him (kids, wife) to learn and apply the important principles which an old wise Physics teacher (Jonah). Soon after Mr. Rogo is greeted with the dilemma of a potential plant closing, he by chance reunites in the airport with Jonah, who seems to have all the right answers for him (despite seeing no relation between Physics and Manufacturing). The old professor provides him with 3 important principles to focus on, which comprise âThe Goalâ. Since we like to discuss Finances here at Share Repurchase, we will make the parallel between The Goal of a Manufacturing Business, with the goal of your Personal Finances! The three things which any company, individual, or family need to focus on are: Throughput, Inventory, and Operational Expense. These will be defined in the following paragraphs for how they relate to Personal Finance.
âGoldratt, or rather Jonah the Professor, defines throughput as the rate at which the system generates money through sales. The Goal for any business is to make money! If your business is not making money, it will eventually shut down. All activities within your business should focus on how it can contribute to making money. In relation to Personal Finance we can think of throughput as your income from your business, income from your salaried/hourly job, or passive income from investments like stock or real estate. When making a budget for yourself as an individual, or for your family, if you donât have any income then thereâs nothing to budget! This is the most important portion of your budget as it is the foundation, and other factors will soon become irrelevant if you do not have any income coming in. Just like any business can go bankrupt once it does not have enough cashflow for a sustained period of time, an individual can go bankrupt as well.
âWhat can a person do to increase Throughput in their Personal Finances? Well for the average American it will start with either: getting a raise, getting a promotion for a higher paying position, finding a new higher paying job, or getting a second job/side hustle to bring in more income. Increasing throughput is the most important factor in staying afloat in business as well as in your personal finances. When looking at your budget, think about the lifestyle YOU want to live. If you are satisfied with your current lifestyle, then maybe increasing throughput is not important to you. Or maybe you were given all of the necessary throughput you will need in your life from a family member or really great friend. How long will that last? Is it guaranteed? Can it cover you if a disaster (natural or health related) strikes? These are just a few things to consider when thinking about your current level of throughput (income) and how it will affect the remaining days/months/years of your life.
âThe next principle we will discuss is Inventory: all the money that the system has invested in purchasing things which it intends to sell. In regards to Personal Finance, we can think of it in a few ways: Savings and/or Discretionary Expenses. I say both Savings and discretionary expenses because this is what is left over (inventory) after the necessary spending or operating expense which we will discuss in the next section. If that is the case, then why would we focus on Inventory before Operating Expense? We can look at two examples, one from the book Profit First and the other from one of the greatest investors of all time, Warren Buffett. In the book Profit First (future Book of the Month) the author does not use the typical equation of Revenue - Expenses = Profit. He uses Revenue - Profit = Expenses. Using this formula instead, ensures that an individual makes a profit with their business, or in our Personal Finance case, their savings in a budget. We are taught early on to focus on our Income first, Expenses second, then with âwhatever is leftâ you should try and save it. For many the âwhatever is leftâ method ends in ânothing is leftâ, but since all of our Expenses (bills) are paid itâs not a huge deal. That is until it is a huge deal! Accidents, injuries, loss of income, and random other incidents and expenses will eventually come and ruin your budget if you use the traditional method of accounting for your income, expenses, and savings (profit). This is why Mike Michalowicz recommends to focus on Profit First.
Donât save what is left after spending; spend what is left after saving
Warren Buffett has a similar principle which he clearly suggests in the quote above. Your inventory (savings), although kept low in comparison to your income, is more important than your spending (Operating Expense). Make a decision on how much you will save each month, between 10-20% of your income, then with the remaining money take care of your day to day expenses. This guarantees 2 things: first you will have money saved for a rainy day, and secondly it will help you to reduce the your operating expense (bills) because you are already working with a lower amount of your income.
If you buy things you donât need, you will soon sell things you need
âAnother Buffett quote (above) which we can use to draw a parallel between Inventory and Personal Finance is discretionary spending. Discretionary spending is the money we spend after we have taken care of our âbasic needsâ: Food, Shelter, Clothing. When I mention food, I donât include going out to eat on a regular basis as food for your basic needs. Having 12 pairs of shoes which are not required for you to increase throughput (income). Even having a home with 10 br and 5ba when you are the only one living in it! These are all considered discretionary spending, as this is money spent to go above and beyond your basic needs. Just as with a Manufacturing company, if it decides to buy or make parts which it cannot immediately consume in order to increase throughput, then it is unnecessary spending which increases Inventory, which is not helpful towards The Goal. Another way we can think of inventory is when you buy items with the purpose of using it âsome dayâ, or buy way more than you need just because something is on sale, or buy too much of a product which has a short shelf life because it was a âgreat dealâ. None of it is worth the expense if youâre unable to use it before itâs no longer worth what you spent on it, or if you end up not making use of it. This money could have been saved and used for a future emergency, or better yet used to invest to help create more throughput through passive income. Keep this in mind next time you see a sale on something you do not truly need, or will not be able to realize the benefit of the product in a timely manner.
The third principle is focused on Operational Expense: all the money the system spends in order to turn inventory into throughput. In Personal Finance this is the part that most people will focus on the most: what are we spending our money on. Operational Expenses would include: food, rent/mortgage, lights, gas and car, as well as other basic expenses which will help you to continue to bring in income. If you donât own a car, this would be your bus pass, Uber or Taxi fair, bicycle, or whatever else you use to travel from point A to point B. For most Americans this section of your Personal Finances has the most number of components, but also should be the only negative component. Controlling your Operating Expense is so important because it has the 2nd largest effect on your personal Finances after throughput (income). It is also the hardest portion for most Americans to control. In a consumer driven society, the natural thing to do is spend money. Advertisers spend billions each year to try and get you to spend more money with their company versus having you spend your money with another business. This means your Goal (increasing income, saving/reducing unnecessary discretionary spending, and reducing operating expense) is in almost direct opposition of the advertising companies Goal in the majority of cases. Companies would love to increase your expenses and/or inventory, in order to increase their own throughput (income).
âAs long as you keep The Goal (YOUR Goal) in mind your business as well as your Personal Finances, will greatly benefit. As the Subtitle suggests, The Goal is a process of ONGOING improvement. Tweaking the steps and process over time is necessary. Always sticking with the status quo of how to get things done, especially when it is not achieving the desired affect, will eventually lead to ruin or bankruptcy. Challenge assumptions which are not working, and challenge yourself to improve those of which are working currently in order to get better over time. Thanks for reading and subscribing to the Share Repurchase Newsletter and Blog! Be sure to leave a comment below, and if you havenât yet, please subscribe to our Blog and Newsletter below. Next month we will review Profit First By Mike Michalowicz.
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Akeem The Dream
I enjoy discussing and learning about technology, stocks, sports, and beating my wife at Dominoes! As I learn, I love to share with family and friends so that we can share our knowledge. Thanks for being apart of the journey!