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Planning Starts With The Basics
By: Jonathan Citrin
When developing a plan for your finances, the toughest question often is: “Where
do I begin?” Before investing in stocks and bonds or buying life insurance,
before implementing any change or making any decisions, you first need to
analyze and understand your entire financial picture. Two documents allow you to
do just that. A Balance Sheet and a Cash Flow Statement enable you to take an
in-depth look at your current financial situation and make better decisions
about the future. With a little work, you can develop these two tools and be on
your way to a solid plan for your finances.
Balance Sheet
A balance sheet is a snapshot of your personal finances at one point in time. It
contains two main elements: what you own (assets), and what you owe
(liabilities). Your net worth is expressed as: Net Worth = Assets – Liabilities.
That is, what you own minus what you owe.
A balance sheet clearly lists all assets and liabilities. Examples of assets
include: house, investments such as stocks and bonds, savings and checking
accounts, 401(k), IRAs, business interests, artwork, and jewelry, among others.
Liabilities include mortgage balances, credit cards, education loans, and any
other debt. Once you have created a list of everything you own and everything
you owe, simply subtract the sum of the assets from the sum of the liabilities-
this is your net worth.
The ultimate goal of most investors is to increase their net worth. The balance
sheet is a very useful tool to identify strengths and weaknesses in your current
finances, as well as to determine your goals for the future. Someone with a
disproportionate amount of liabilities might set a goal to eliminate this debt.
On the other hand, someone with a positive net worth (more assets than
liabilities) might plan to save and invest towards retirement, college, or
another goal.
Cash Flow Statement
After analyzing your balance sheet and determining your goals, you need to
decide how to fund these goals. A well formulated plan is one not only with
realistic goals, but also a sensible means of achieving them. That is, having
goals is good, but you must be able to pay for them. Using a cash flow statement
will enable you to determine how to pay for your goals.
A cash flow statement is a detailed look at all money coming in and going out
over a period of time. It illustrates what you earn (revenue) and what you spend
(expenses). Your net cash flow is expressed as: Net Cash Flow = Revenue –
Expenses. That is, what you earn minus what you spend.
Some examples of revenue include: salary and wages, self-employment earnings,
dividends, interest, and other investment income. Expenses may include: mortgage
payments, rent payments, insurance costs, utilities, clothing, food, child care,
alimony or child support, travel, entertainment, loan payments, education costs,
taxes, charitable contributions, gifts, and gasoline. After listing all you earn
and everything you spend, you can calculate your net cash flow by simply
subtracting expenses from revenue.
By analyzing your cash flow statement, you can more easily cut expenses and
identify excess net cash to use towards your goals. Generally, someone with
negative net cash flow should first concentrate on cutting expenses to achieve
positive cash flow before attempting to save or invest towards any future goals.
Once positive net cash flow is achieved, excess money can be used directly for
funding and achieving your goals.
In developing a balance sheet and a cash flow statement, it is important to
remember one general rule-of-thumb- Quality in – Quality out. The more detail
and care you put into your planning documents, the more effective they will be.
A plan is only as good as the effort you put forth when creating it.
About the Author:
Jonathan Citrin provides financial goal planning services. Go to
http://articles.citringroup.com
for hundreds of educational articles about Personal Finance, Retirement
Planning, Investment Planning, and College Savings. |
