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How Much Do You Owe?
There are numerous 'how to' guides which help you achieve your life goals or transform your finances but how many of these focus on what to do at a very practical level. This article looks at how organising your filing cabinet and preparing balance sheets and profit and loss statements can provide invaluable insight to help you achieve your life goals.
Copyright (c) 2007 WealthBeing
Goal setting plays a powerful role in helping individuals achieve what they want out of life. Research suggests that setting goals increases the probability of achieving objectives from 5% to 70% and increases productivity by an average of 19%. In order to set realistic financial goals, you first need to understand your current financial picture. Filing enables you to organize your finances and give you real confidence when making financial decisions.
There are three steps to determining your financial picture:
1. Filing
2. Completing a Profit and Loss Statement
3. Completing a Balance Sheet
At this point it is easy to say that doing this type of work is just too boring – who can get excited about filing and bookkeeping, right? However, stop and think about why it is you are saying this. Is it really because it is too boring or is it because you are reluctant to see the reality of your current financial situation? Remember, as Brian Tracy says, “Every minute you spend in planning saves 10 minutes in execution; this gives you a 1000 percent return on energy!”.
1. Filing
Create a filing system to track all of your monthly income and expenses. This will form the basis of your profit and loss statement and balance sheet. Within income set up a separate file for each area of income you receive:
Pay slips Interest payments Dividends Rental income Royalties Other
Similarly, for expenses set up a file for each regular expense item:
Mortgage
Credit Card
Utilities
Car Food
As we organize many of our day to day expenses by direct debit it is useful to have our bank statements listed alongside our income and expenses.
You will also need files for
Important personal information (birth certificate, marriage certificate, passports)
Insurance policies
Legal Documents (wills)
Pension
Tax
2. Completing a Profit and Loss statement
Profit and Loss statements are also known as “income statements”. When you track your income and expenses every month, right down to the cash you take out of the cash machine, you can instantly see whether you are making or losing money each month. This is incredibly empowering yet so few people undertake this.
Profit and Loss statements list all of the income you earn and all the expense you incur each month. Provide as much detail as possible. The amount in your income column should balance with that in the expense column. What’s left is your profit or loss.
Analyse the profit and loss statement:
Are you living within your means (income greater than expenses) or are you getting further and further into debt (expenses greater than income)?
What are you investing in? What are you throwing your money away on? Where is your income coming in from? Are you totally reliant upon one form of income?
Do you know what you’re spending your cash on each month?
Finally, what should you be spending your money on to achieve your life goals?
3. Completing the Balance Sheet
Unlike the Profit and Loss statement, a balance sheet provides a snapshot of your worth at a particular time. As such it reflects your past financial habits.
A balance sheet includes everything you own – your assets – and everything you owe – your liabilities.
In the liability column, begin to recognise what is good debt and what is bad debt. Good debt is attached to an asset and you acquire good debt as you grow wealthy. An example might be a mortgage on an investment property which is producing positive cash flow through rent. ‘Bad debt’ is consumer debt and it’s attached to your lifestyle choices. For instance, an outstanding balance on a credit card which has been used to purchase a nice pair of shoes or an expensive night out would be considered ‘bad debt’.
Subtract the total amount of your liabilities from the total amount of your assets to determine your net worth.
Analyse your balance sheet:
Where is your money tied up? Do you own any major assets besides that of your residential home?
What percentage of your liabilities is made up of bad debt and what percentage is made up of good debt?
Finally, what should be the sum of your net assets to provide you with the income you desire in retirement?
Preparing your balance sheet and income statement first enables you to set financial goals which are both realistic and meaningful. Filing is the first step in this process, however boring this may seem.