If your life were an enterprise, you would be the chief executive officer. Much like the CEO of a company, you determine your path and then you set out to accomplish your goals. As CEO of a business, you would never let a month go by without having a very firm grasp on your company's finances. You would understand that failure to keep track of financial performance could mean the end of your company and your dreams. In fact, the importance of tracking financial performance seems to be a given in any business context, yet it is a practice that seems to elude so many when it comes to personal finances.
The importance of understanding and tracking your personal finances cannot be overstated. If you don't know where your money is going every month and how much of it you have left, you will find it nearly impossible to make sound financial decisions. While keeping close tabs on your finances requires discipline and organization, there are some very basic, time-tested and manageable ways to do it.
You can create a map of your personal finances by preparing monthly financial statements for yourself or your household. These financial statements provide a way to view a snapshot of your current financial picture, identify positive and negative spending and income trends and determine how much cash you have available to "reinvest" in your life.
Creating Financial Records
Before you can create financial reports, you must first make sure to compile good financial records. Financial records and reports can be generated electronically using a personal finance and accounting software program. Your record entries should include the date of an income event or expenditure and the amount of money you earned or spent. By developing detailed records of your historical financial performance, you can analyze your past performance and project future results. Once you have organized your records, you can use that information to create your personal financial statements, which include cash flow statement, income statement and balance sheet.
Cash flow measures your personal financial health. By preparing a monthly cash flow forecast, you can track all of the income and expenses you expect to earn and spend each month and determine whether you will have shortfalls or surpluses of cash. Ideally, you should project cash flows out for twelve months, so that you can see when you might experience a need for more income (or less spending) and can plan how to meet those needs before problems arise. The goal is to improve your cash flows by generating more income and reducing cash outlays so that you can keep your personal going concern going strong.
An income statement, also known as a profit and loss statement, measures your financial performance over a specific period of time. It is essentially a report on your cash generating ability and, after factoring in income and expenses, shows the amount of money you will have available for savings, investments or additional expenses. To prepare an income statement, you will record income from wages, tips, royalties, salaries, commissions and the like. Then you will record expenses. There are two main types of expenses — fixed and variable. Fixed expenses are expenses that you must pay for necessities each month, such as a mortgage payment, rent, school tuition and insurance. Variable expenses, on the other hand, are expenses that may change from month to month, such as food, entertainment, clothing, fuel, and telephone and Internet charges, to name a few. Your goal in preparing monthly income statements should be to keep your income levels higher than your expense levels, resulting in a monthly surplus that you can apply towards an emergency fund, a savings or investment account or other activities that can increase your overall net worth.
A balance sheet is a snapshot of your financial picture at any given point in time. It identifies your assets, liabilities and net worth. One side of your balance sheet lists your assets and the other side lists your liabilities. An asset is any item of economic value that you own, such as cash, real estate or personal property. A liability is basically any debt or other obligation to pay someone else. In order for your balance sheet to "balance," your assets plus your net worth must equal your liabilities. By giving you the opportunity to create a clear picture of your assets and liabilities, a balance sheet can help you to gain a better understanding of your current financial situation.
What Keeping Track Can Do For You
Keeping track of your personal financial situation enables you to assess whether you have enough liquidity in case of an emergency (e.g. six months' worth of living expenses), whether you can meet debt obligations relating to your mortgage or other loans and whether you are saving enough money each month to achieve your financial goals. If you are one of many who have fallen into the trap of thinking it is not necessary to keep close track of your personal finances, you need to start thinking more like the CEO of your financial future. The sobering reality is that if you fail to keep track of where your money comes from and where it goes each month, you can quickly find yourself without it when you really need it.
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