How many of us have thought at one time or another, “Where does all my money go?” It doesn’t matter how much or how little you make, the key to financial success is control. While some people are born lucky with a lot of it, some others land up making a lot and yet find themselves in a poor state towards end of each month. In contrast, there are some who seem to do very well even with very little. In fact, it’s not at all uncommon for a lot of people to go from rags to riches and back to rags.
Several examples come to mind of famous people who have been through that cycle, with some having sprung back yet again – Mark Twain, Thomas Jefferson, Boris Becker have all gone that route and ended in bankruptcy. Amitabh Bachchan, has bucked the trait by going back to riches are facing bankruptcy in the late 1990s. It is easy to avoid thinking about the financial future, when dealing with the present is difficult enough. However, don’t forget the simple rule of life that nothing happens without a plan.
Control your money
Planning and budgeting require control and it doesn’t come naturally. Without the ability to measure our financial health and develop a plan and budget, we will not achieve our financial goals. However, making and sticking with a plan isn’t necessarily easy, and it often involves what some people would consider sacrifices. The fact is that the rewards of taking financial control are worth any small sacrifices and more. After all, you don’t want to share the fate of celebrities who have gone from being rich to paupers because they lacked financial prudence.
Before you can decide how much you need to save to reach your financial goals, you have to measure your financial condition — what you own and what you owe. Just the way companies use a balance sheet for this purpose, so can you. A personal balance sheet is a statement of your financial position on a given date — a snapshot of your financial status at a particular point in time. It lists the assets you own, the debt or liabilities you have to service and your general level of wealth, which is your net worth or equity. Assets represent what you own. Liabilities represent your debt or what you owe. To determine your level of wealth or net worth, you subtract your level of debt or borrowing from your assets.
50% of income towards household expenses
Net worth is important to know because it represents the level of wealth you have accumulated. For instance, if your liabilities are greater than the value of your assets, then your net worth is negative, a situation which is not the best to be in. This state arises from consuming more than you take in financially. This should not dishearten you, especially if you are in the beginning of your career and have taken up loans to build assets. Likewise, it is natural for a 25-year-old to have a considerably lower net worth than a 45-year-old. You could checkout on how to interpret your net worth in the story on measuring your financial health a few pages later.
Tracing your Money
Although income is usually very easy to calculate, expenditures usually are not. This is so because many expenses do not leave a proper paper trail. So, it’s hard to keep track of all the little things you spend your money on. But to create a valuable personal financial plan, you must understand where your money goes. Some financial planners also classify living expenses as variable or fixed expenditures, depending on whether you have control over the expenditure. These classifications are appealing, but not all expenses fit neatly into them. For example, it’s difficult to categorise car or home repairs as being either variable (you have a choice in spending this money) or fixed (you have no choice in spending this money). They could be postponed but probably not for too long.
The next step in creating a personal financial budget is to keep and maintain records. First, without adequate records it’s extremely difficult to prepare taxes or know where the money is going. In short, if you don’t know where and how much you’re spending, you don’t have control of your finances. Most importantly, organised record keeping makes it easier for someone else to step in during an emergency and understand your financial situation.
15% of income towards retirement
Record keeping really involves two steps: tracking your personal financial dealings, and filing and storing your financial records in such a way that they are readily accessible. Very simply, if you don’t know where financial records are, you won’t be in control of your affairs. In determining how best to track your personal financial dealings, you must keep in mind that the best system is one that you will use.
This method will help you generate a monthly income statement. You then compare this monthly income statement with your annual and target income statements to determine whether or not you have any problems. Sure, the process may be tedious, but it’s necessary. Remember, your budget is your best friend, because the key to controlling expenditures is to keep track of them.
Budgeting
By the time you read this, the Union Budget would have been announced, with experts deliberating the pros and cons of the announcement and its impact. Yes, there is something as simple as your own personal finance budget, if you are wondering what it is all about. In times when patriarchal families were the norm, it was common for the entire household to have a budget, which was typically managed by the older women of the household.
Somehow, these families always had the money for everything that was planned, besides unexpected emergencies and circumstances. If you find it tough to manage your household expenses on your salary or find wide differences in expenses each month, it would be a good idea to take cue from the National budget and set one up for your home as well.
Simply put, a budget is really nothing more than a plan for controlling cash inflows and outflows. The purpose of the cash budget is to keep income in line with expenditures plus savings. Your cash budget should allocate certain dollar amounts for different spending categories, based on your goals and financial obligations.
To prepare a budget, you begin with your most recent annual personal income statement. First, examine last year’s total income, making any adjustments to it you expect for the coming year. Based on your income level, estimate what your taxes will be. This figure provides you with an estimate of your anticipated after-tax income available for living expenditures, which is commonly called take-home pay.
Just as your estimate of anticipated take-home pay flows from your most recent annual personal income statement, so does your estimate of living expenses. Using last year’s personal income statement, identify expenditures over which you have no control — fixed expenditures. Then determine your variable expenses. These are the expenses over which you have complete control, and you can increase or decrease them as you see fit. Finally, subtract your anticipated expenditures from your anticipated take-home pay to determine income available for savings and investment. Now that you know where you stand financially with a budget, you will understand the importance of having one for your financial plan to be in place and achieve your financial goals.
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