Have you ever tried setting a goal without any way to measure it? You can imagine that’s hard. On top of that, how do you know if you have improved, if there is no way to measure it? Somethings in life are hard to measure but your finances are not one of them ?. Knowing where you stand financially continues our 101 series discussion on financial well-being.
Early on, in my business education I learnt about the financial statements that help us understand how well a company is doing. The most basic ones are the income and expenditure statement, the cash flow statement and the balance sheet. As we translate that to personal finance, it is no different! At the very basic level, there are 2 basic statements everyone of us should be looking at on an ongoing basis – our income and expense statement and our net worth statement (balance sheet). Today, we are going to dig into both and understand why we want to look at these and at a high level, how we go about preparing these. If you are someone who already tracks this, you are well ahead of the curve!
The income and expense statement and the savings rate
At the very basic level, it is exactly what it says. It looks at your income, your expenses and the difference between them (hopefully positive) is your savings. Ideally you should track this on a monthly basis but to get started, you can do this quarterly or annually. The more regularly you do this, the easier it is going to be to keep on top of this.
Why do I care about this? If you recollect, in my first article, I talked about one of the pillars on making sure you keep the gap between income and expenses large (a.k.a what my grandpa used to say – live below your means). This is the foundational element to understand what your savings rate is, if any. The savings rate tells you how strong a financial position you are putting yourself in and more importantly, how long its going to take for you to comfortably retire or achieve a savings goal you may have.
How do I prepare this statement? On the income side, look at your paystub, subtract taxes to get your net income after taxes. Your expenses on your health insurance and benefits should fall under your monthly expense bucket. Any 401k contributions should be in your savings bucket. If you have other sources of income through side hustles or interest income or anything else, you should include all that.
On the expense side, you can track your expenses either through online tools like Mint.com or YNAB or a basic spreadsheet by collecting all your credit card and bank statements. This can be time consuming if you have never done it before. But trust me, its worth doing this. You need to know where your money is going. After this, you will have the below 2 numbers:
Net Income after taxes
(-) Expenses (including benefit contributions)
= Savings
Savings / Net income after taxes = Savings %
Most financial advisors and experts will advice you to save around 20% of your income. If that feels too much, don’t worry. You need to start somewhere. Even if that number is miniscule, you now have a baseline. And you can start thinking about how to improve it over time.
Net worth statement (the personal balance sheet)
A net worth statement is a statement of your assets and liabilities. Your net worth is your liabilities subtracted from your assets. An asset is anything that has value in the market. Examples are your home, cars, cash in the bank etc. Liabilities are debts you owe. Examples are your mortgage, car loans, credit card debt, student loan debts etc. Remember, a net worth statement is a snapshot at a point in time. You can track this monthly, quarterly or annually.
Why do I care about this? People sometimes tell me, “I am not Bill Gates to get featured on Forbes magazine. Why on earth do I even track my net worth?” For sure, we don’t do this to brag to others or on the other end, make us feel terrible how “poor” we are ?. At the basic level, it’s a financial report card on how you are doing. It enables you to answer questions like, “can I afford to buy something? How far am I to retirement?” It helps you make some decisions. To those who have a negative net worth (where their debts exceed their assets), it tells them they need to start making some decisions on how to correct this (if you have not already done so).
How do I prepare this statement?
For your assets, below are some of the most common assets for you to think about and list:
- Cash in checking and savings accounts
- Market value of your residence, other property, your car(s), other vehicles you own
- Current market value of your retirement accounts like your 401k, IRAs, 403bs, HSA (Health Savings Account) if you maintain one.
- Current market value of any stocks or bonds you may hold in your trading accounts
Next, list your liabilities. Most common liabilities for you to think about are:
- Home mortgage and mortgage on any other property you may have
- Student loans, personal loans, car loans, long term credit card debt
Assets
(-) Liabilities
= Net worth
You can track your net worth in a simple spreadsheet or use automated online tools like Mint.com and Personal Capital. More importantly, you want to track progress of your net worth over time.
Thank you for reading! I wish you luck in your financial well being journey!
Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.
