Personal Finances and Budgeting

Your Personal Finances

Everyone has their own unique relationship with personal finances. Everyone will also have a different income level, sources of income, assets, liabilities, and expenses. There are two statements that can help you understand your own personal finances: your cash flow statements and your balance sheet.

The cash flow statement will measure the cash flowing in and out of your life during a specific period. This allows you to calculate your net cash flow. Examples of cash inflows will be your salary, a dividend that you receive from your investments, or the sale of something you own. Cash outflows will consist of expenses you incur, such as your rent, utility bills, or car payment.

Once you have picked a specific period, you can discover your net cash flow. You will want to look at your inflows for that time period and subtract your outflows from it.

For example, say you want to create a cash flow statement for the month of January. You have an income of $3,000 for that month, and you also have the following outflows throughout the month:

• Rent—$500
• Cell Phone—$100
• Utilities—$100
• Auto Insurance—$150
• Groceries—$400
• Gas—$200

Add those up, and you get $1,450 in total cash outflows. You can then calculate the net cash flow by doing the following: $3,000 (inflows) - $1,450 (outflows) = $1,550. You get a positive net cash flow!

Sometimes you will come across a situation where there is negative net cash flow. This would be where the outflows exceed the inflow.

The balance sheet can help you understand your net worth and will list out your assets and liabilities. Think of it as a snapshot of your current financial situation. Assets are going to explain the value of what you own and are measured at their fair market value or current value in the current date's dollar. Liabilities will be what you owe and will be measured in the current balance that you owe.

Assets can usually be broken down into three distinct categories:

• Liquid assets are assets that can easily be turned into cash. Some examples are checking and savings accounts, money market accounts, and cash.
• Large assets are things like your house, a car, boat, art, and other property. Again, these should be measured at their fair market value. If you cannot find a fair market value, try to find the sale price or recent sale prices of a similar asset.
• Investment assets are assets that can generate cash flow or are speculated to increase in value over time. This could include stocks, bonds, mutual funds, real property, and annuities.

Liabilities are more straightforward and can be considered as debts that you have to pay back. Liabilities can often have an interest charge attached, so you could end up paying more than the balance shows over the life of the liability. Don't include the interest charge when figuring the amount of the liability. Some examples could be your mortgage, the balance that you owe on your car, credit card balances, student loan balances, a medical bill, and so on.

To calculate your net worth, you simply take the total value of your assets and subtract your liabilities from it. So for example, if you own a home worth $200,000 and you still owe $80,000 on that home, you would do the following: $200,000 (Asset) - $80,000 (Liabilities) = $120,000 (Net Worth).

The example above shows a positive net worth. Unfortunately, it is very common to get a negative net worth. Referring back to the example, let's pretend that you still owe $80,000 on the home, but you're also paying off student loan debt with a balance of $100,000 and credit card debt with a balance of $25,000. Using the formula of Total Assets - Total Liabilities = Net Worth, you can see that the new numbers will result in negative net worth (200,000 - (80,000 + 100,000 + 25,000) = (-$5,000).

Budgeting

You've now learned two tools to help you assess your current financial situation. Now you will want to develop a budget or spending plan that will allow you to take control of the flow of your money. This will help you make important financial decisions.

In order to create a budget, you will need certain documentation. First, you will want documents that show your income. These can be pay stubs, profit and loss statements if you are self-employed, dividends, alimony, child support, public assistance, and so on. It will be important to know the gross income (the amount you receive before any taxes or deductions), the tax and deduction amounts coming out of your paycheck, and the net income (the amount you actually take home). If you are self-employed, you can use your profit as your income to work with for your personal budget.

You will now want to determine what your expenses are. Most people create monthly budgets, so think about what your common expenses are each month.

There are two types of expenses that will be included in your budget. Fixed expenses will usually be the same expense each month. These will be things like your mortgage or rent, car insurance (if monthly), car payment, and so on. Variable expenses will be expenses that can change from month to month. Examples would be your grocery bill, any eating out you might do, entertainment, and so on.

If you are unsure what your variable expenses are each month, there are a couple of common ways to get a better understanding of what you truly spend your money on. The first would be to go through the last 60 days of your bank or credit card statements and add up all of your variable expenses. Divide that by two, in order to get a good idea of what you are spending each month. The other method would be to keep a spending journal, where you track all of your expenses over the course of two months. Be sure to spend like you normally do to get a fair picture. After the two months are up, review the numbers and add them up. If they are exceeding your income, you need to reduce your spending.

Of course, you do run into expenses that may not happen each month. This can be things like car repairs, holidays or birthdays, summer camps, a medical bill, and so on. You can call these irregular expenses, and you need to account for them differently in your budget. You can do this by adding these kinds of expenses up for the year and dividing by 12. You then put that number in the appropriate category for the monthly budget. The idea is to be sure you are putting that money away each month into a savings or checking account so you have the cash available once the expense occurs and you don't have to rely on credit to pay for it.

The overall goal is to have your income be greater than your total monthly expenses. Only then can you begin the new adventure: saving!