The first thing I learned about Chemical Engineering as an undergraduate was Mass Balances. In summary, all of chemical engineering is governed by:

In + Generated = Out + Accumulated

Pretty basic stuff, but this principle applies in general to any kind of scientific process out there: electricity, heat, motion, chemical reactions etc. If you have ever taken a science course, you have surely encountered this expression in some simplified form (also known as conservation of mass)

Here’s the real geeky part: this balance also applies to finances. Financially, this  equation looks like

Money in + Money Generated = Money Out + Money Accumulated

In: For chemical engineering, the mass in refers to the raw materials coming into the reactor. This is the starting point of all chemical reactions.  Similarly in finance, the money in is your income and just as in engineering, it’s the starting point. It comes in form of income from your job, parents, relatives etc.

Generated: A generated mass in chemical engineering refers to materials that are being formed within the reactor. The raw materials are mixing and colliding to form new materials. In finance, money generated is the additional money you can get from your income i.e. interest (on investments, savings accounts etc). One of Murphy’s laws says “Before you do something, you always need to do something else”. Before you generate money, you need to begin with money (income).

Out: In chemical engineering, these are the materials that are leaving the reactor. It usually contains some of the raw materials that didn’t convert and the products you are trying to generate. In finance, money out would be the expenses e.g. bills, taxes, overdraft fees etc.

Accumulated:  In chemical engineering, these are the materials that stay in the reactor without coming out. It is on the same side as the materials coming out because this is detrimental to the process. Therefore for a chemical engineer, accumulated materials are BAD. This is where finance and chemistry will disagree because money accumulated is a good thing. It’s actually what determines your wealth. If I rearrange the previous equation,

Money in + Money Generated – Money Out = Money Accumulated

In the words of Archimedes: EUREKA! Money Accumulated is essentially your NET WORTH and is the determinant of your financial health.

While most people only focus on increasing income as way to accumulate money, this equation shows that if attention is not paid to the other two factors, it won’t have any effect. Take into consideration how much you are making now and compare it to 1 or 2 years ago? You’re probably making more money, but as your net worth increased? Are you keeping more of the money you’re making? I have found that as soon as I started making more money, the things I wanted increased. So my equation was a mess and often resulted in negative accumulation. It’s not just enough to earn more, you need to control your expenses and let generate interest.

In the illustration of a reactor, it’s even clearer to see why accumulation and generation are often easy to ignore. These are the things happening behind the scenes (inside the reactor) that you don’t notice. Unfortunately, that which is easily overlooked is often very important. We feel the joy of earning money and the pain of expenses, but there is hidden joy in generating and accumulating money as well.

Overall, there are 3 ways (mathematically) to increase your Net Worth/Accumulated:

1. Increase Money in (Income)
2. Increase Money generated (Compound Interest)
3. Decrease Money out (Expenses)

We’ll get to look at each of these in the week(s) to come.

Picture courtesy of http://www.biofilters.com