Month after month, many individuals look at their bank and credit statements and are surprised that they spent more than they thought they did. To avoid this problem, one simple method of accounting for income and expenditures is to have personal financial statements.
Just like the ones used by corporations, financial statements provide you with an indication of your financial condition and can help with budget planning. There are four types of personal financial statements:
1. The Net Worth Statement
2. The Income and Expense Statement
3. The Cash Flow Statement
4. The Balance Sheet
The Net worth Statement:
The first step in assessing ones current wealth is determining ones net worth. It is the beginning of financial planning. It provides an indication of your capacity to achieve your financial goals. The process consists of 3 steps:
1. List the items of value that you own – these are your assets
2. List the amounts that you owe to others
3. Subtract your liabilities from your assets
4. The Difference being your NET WORTH
Net worth is a tool for comparing the changes in your financial position over a period of time. An increase in the net worth is a favorable trend, and a decrease is net worth is a reduction in wealth.
There are a number of good practical reasons for preparation of the Net Worth statement:
• Money Management
• Incentive for Saving
• Estate Planning
• Insurance Planning
• Helps in case one needs to borrow
The Income and Expense statement:
The Income and Expense statement helps in understanding how much one has earned and spent during a particular period.
1. List all income received during the time period
2. List all expenditures made during the time period
3. Determine the surplus / deficit of income over expenditure
The Cash Flow Statement:
Controlling your financial affairs requires a cash flow statement. A cash flow statement allows one to know exactly how much, money you have. The statement shows how the funds are allocated, how they are working for you, what are your plans for them, how far one has reached in achieving the goals set.
While the net worth statement is a great way of assessing your financial well being, it captures only a frame of your financial position at one time.
Unlike your net worth statement, the cash flow statement tracks your income/expense on a regular basis. And because you are recording all your transactions, coming in or going out, this makes your cash flow statement dynamic, allowing you to review your financial route from time to time.
The statement will also:
• Indicates the ability to save and invest
• Helps analyse the Standard of Living
• Indicates whether one is living within or beyond one’s means
• Highlights any problem areas
The Balance Sheet:
A balance sheet is the fourth type of personal financial statement. A personal balance sheet provides an overall snapshot of your wealth at a specific period in time. It is a summary of your Assets (what you own), your Liabilities (what you owe) and your Net Worth (assets minus liabilities).
