In this blog post, I want to talk about the differences between passive and active income and how they relate to your business.
THE BASIC DIFFERENCE BETWEEN ACTIVE INCOME AND PASSIVE INCOME
Active income is money you earn that requires your effort.
For example, if you sell a service that you must first complete – such as freelance writing, graphic design, etc. – you are being paid for a combination of time, skill, and effort. And if you don’t put in that combination of time, skill, and effort, you don’t get paid. Or if you sell a product that requires some work on your part (i.e. to assemble or customize or ship), that is active income as well.
Passive income is money you earn without any effort on your part.
For example, if you write a book, you can sell it and earn passive income because you only need to write the book once.
UNDERSTANDING ACTIVE INCOME AND PASSIVE INCOME
Active income is commoditized. You get paid proportionate to the amount of time, skill, and effort you put into the product or service you provide. In other words, for every product or “unit of service” you provide, you get paid. If you want to make more money, you have to provide more products or units of service.
Passive income is a bit of a misnomer. It should really be called non-commoditized income. When brand new entrepreneurs hear the words “passive income”, they start to salivate because it sounds like you’re getting a ton of money with no effort at all. Experienced entrepreneurs know that passive income takes some work to set up and run… but it’s non-commoditized because the money you make is not as closely tied to the effort you put in. You can start an ad-based blog and put in hours of time in the beginning to add content and market it, but you can easy up in the future as traffic builds. Eventually, you can run the business with very little effort on your part.
A good example of the difference between active and passive income is to look at two different real estate investors.
- One real estate investor flips houses. She buys a house, fixes it up and sells it. That’s active income because she gets paid as long as she’s buying, fixing, and selling.
- A second real estate investor rents houses. She buys a house and rents it out. There is a little effort in the beginning to buy the house and maybe fix it up a bit, and there might be some ongoing effort to maintain the property and collect rent, but ultimately it’s passive income because the second investor gets paid on an ongoing basis for her initial effort even if she doesn’t buy and rent any more houses.
WHICH TYPE OF BUSINESS SHOULD YOU RUN?
Your ultimate business goal should be to build a passive (non-commoditized) business that doesn’t require you to put in an hour of effort to get paid for that hour. But realistically, you need cash flow first and it’s very easy to start up an active income business that produces cash flow. So if you’re just starting out and you need some cash, start with an active business but immediately begin building passive income opportunities (i.e. ebooks, ads, and rental houses) into your business model.