Steve TeSelle, CFA, CFP ™
January 2001
The Statement of Financial Position
Maybe you want to take care of your own finances, or maybe you want to enlist someone to help you. Either way, one of the first things you need to do is understand your current financial position. The way you get a handle on this is with a balance sheet and cash flow statement.
The balance sheet lists your assets and liabilities. Here's an example:
|
ASSETS |
LIABILITIES AND NET WORTH |
||
Cash and Equivalents |
Liabilities |
||
|
Checking |
$10,000 |
Mortgage |
$200,000 |
|
Total Cash |
$10,000 |
Total Liabilities |
$200,000 |
Invested Assets |
|||
|
Stock Portfolio |
$80,000 |
||
|
IRAs |
$20,000 |
||
|
Total Invested Assets |
$100,000 |
||
Use Assets |
|||
|
Residence |
$300,000 |
||
|
Car |
$15,000 |
||
|
Personal Property |
$30,000 |
||
|
Total Use Assets |
$345,000 |
Net Worth |
$225,000 |
|
TOTAL ASSETS |
$445,000 |
TOTAL LIABILITIES AND NET WORTH |
$445,000 |
I suggest separating assets that you invest from assets that you use. Why? Because assets that you use are unlikely to be bought and sold; these are things that you're likely to hold onto. You don't want to turn them into cash unless you're in dire straits. In contrast, invested assets represent savings that you have available for a particular purpose, such as retirement. There's no one way to do this; so use your best judgment.
The make-believe Hips are generally in pretty good shape. Their liability side of the balance sheet looks particularly strong. The only debt is the mortgage, and the mortgage is only 67% of the value of the house. On the asset side, if the Hips are young, then their savings look OK, but if the Hips are in their 50s, only $100,000 raises a big red flag. Do they have a pension? When do they plan to retire? Are they counting on an inheritance?
Next is the income statement. If you haven't been keeping track of your budget, this could take a little while to get a handle on. You want to keep track of income and expenses over several months because most of us have expenses that crop up every few months, or every so often. If we try to estimate a budget from a one-month example, we're likely to miss those abnormal expenses (for me, it's always the car that creates these non-monthly bills).
Try to allocate expenses as conscientiously as possible. If you throw a lot
of expenses into the catch-all miscellaneous category, you'll end up with an
amorphous blob in your budget labeled 'miscellaneous'. Not much help. On the
other hand, you don't want to end up with so many categories that your mind
swims when you look at your budget. You're the one who knows what makes sense
to you, so give it your best shot. Here's one suggestion: You might split the
food category into grocery store and restaurant sub-categories. That way you
can see if you're spending a lot on eating out.
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Here's a cash flow statement example:
|
INFLOWS |
|||
Salaries |
$70,000 |
|
|
Dividends and Interest |
$200 |
||
|
TOTAL INFLOWS |
$70,200 |
||
| OUTFLOWS | |||
Savings/Investments |
$10,000 |
||
Fixed Outflows |
|||
|
Mortgage |
$18,000 |
||
|
Insurance |
$1,000 |
||
|
Property tax |
$2,000 |
||
|
Taxes |
$15,000 |
||
|
Utilities |
$2,400 |
||
|
Total |
$38,400 |
||
Variable Outflows |
|||
|
Food (groceries) |
$8,000 |
||
|
Food (restaurant) |
$4,000 |
||
|
Clothing |
$2,000 |
||
|
Medical/Dental |
$1,000 |
||
|
Entertainment |
$3,600 |
||
|
Transportation |
$1,200 |
||
|
Miscellaneous |
$2,000 |
||
|
Total |
$21,800 |
||
|
TOTAL OUTFLOWS |
$70,200 |
Now you can start to get down to the interesting stuff. Let's say you took my advice and subdivided the food category. Maybe you spend $670 a month on groceries and $330 eating out. That's fine; eating out seems to be a priority. But if you're looking for places to save, you could cut back on eating out, buy a few more groceries, and put the rest into savings. Or maybe you're spending $200 a month on dry cleaning, hidden in the miscellaneous category. Is there any wiggle room there? Do you need to spend that much?
Don't get me wrong. I'm not one of those folks who spends all my time figuring out how to save $1.50. If eating out is a priority, great. Just realize that maybe you have to do without other things in order to eat out.
The only way we can make the budget work is to stop feeding the cats. Well, that was easy.
You've probably heard about various rules, such as that you should have three to six months of monthly expenses in a cash account for emergencies. Well, maybe. Remember, rules are like adjectives: they're useful, but you don't want to get carried away with them. If your job is a bit risky and you don't have any other resources, you'd probably want a healthy reserve to keep your finances from unraveling if you lost your job or became disabled. If you have a steady job and tax-free disability income that kicks in after one month, and the definition of disability isn't too restrictive, you'd probably be OK with a smaller cushion. With that preamble, here are some guidelines from the College of Financial Planning that may help you as you try to decipher your finances.
The important point about engaging in this happy little exercise is not to fit within some guidelines but to have the information in front of you so that you can have a clear picture of where you stand. If you think you're too close to a cliff, make a few informed decisions so you can take a few steps toward financial security.
Steve TeSelle
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