Many individuals look at their bank and credit card statements and are surprised by how much they've spent. One simple method of accounting for income and expenditures is to keep 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 two types of personal financial statements: the personal cash flow statement and the personal balance sheet.
Key Takeaways
- You can create your own personal financial statements to help with budget planning and to set goals for increasing your net worth.
- Two types of personal financial statements are the personal cash flow statement and the personal balance sheet.
- The personal cash flow statement measures your cash inflows or money you earn and your cash outflows or money you spend. This determines if you have a positive or negative net cash flow.
- A personal balance sheet summarizes your assets and liabilities to calculate your net worth.
Personal Cash Flow Statement
A personal cash flow statement measures your cash inflows and outflows to show you your net cash flow for a specific period. Cash inflows generally include:
- Salaries
- Interest from savings accounts
- Dividends from investments
- Capital gains from the sale of financial securities like stocks and bonds
Cash inflow can also include money received from the sale of assets like houses or cars. Your cash inflow essentially consists of anything that brings in money.
Cash outflow represents all your expenses regardless of size. Cash outflows include these types of costs:
- Rent or mortgage payments
- Utility bills
- Groceries
- Gas
- Entertainment, such as books, movie tickets, and restaurant meals
The purpose of determining your cash inflows and outflows is to find your net cash flow. Your net cash flow is simply the result of subtracting your outflow from your inflow. A positive net cash flow means that you earned more than you spent and you have some money left over from that period. A negative net cash flow shows that you spent more money than you brought in.
Personal Balance Sheet
A balance sheet is another type of personal financial statement. A personal balance sheet provides an overall snapshot of your wealth at a specific period in time. It's a summary of your assets or what you own and your liabilities or what you owe. It results in your net worth: your assets minus liabilities.
Your Assets
Assets can be classified into three categories:
- Liquid Assets: These are things you own that can easily be sold or turned into cash without losing value. They include checking accounts, money market accounts, savings accounts, and cash. Some people include certificates of deposit (CDs) in this category but the problem with CDs is that most of them charge an early withdrawal fee, causing your investment to lose a little value.
- Large Assets: Large assets include houses, cars, boats, artwork, and furniture. Make sure to use the market value of these items when you're creating a personal balance sheet. You can use recent sales prices of similar items if it's difficult to find a market value.
- Investments: Investments include bonds, stocks, CDs, mutual funds, and real estate. You should record investments at their current market values as well.
Your Liabilities
Liabilities are what you owe. They include current bills, payments still owed on some assets like cars and houses, credit card balances, and other loans.
The "debt avalanche" and the "debt snowball" are two popular methods for paying off liabilities such as credit card debt.
Your Net Worth
Your net worth is the difference between what you own and what you owe. This figure is your measure of wealth because it represents what you own after everything you owe has been paid off. You owe more than you own if you have a negative net worth.
You can increase your net worth by increasing your assets or decreasing your liabilities. You can increase assets by increasing your cash or increasing the value of any asset you own. Just make sure that you don't increase your liabilities along with your assets.
Your assets will increase if you buy a house but your liabilities will also increase if you take out a mortgage on that house. Increasing your net worth through an asset increase will only work if the increase in assets is greater than the increase in liabilities. The same goes for trying to decrease your liabilities. A decrease in what you owe has to be greater than a reduction in assets.
Bringing Them Together
Personal financial statements give you the tools to monitor your spending and increase your net worth. They're not just two separate pieces of information. They work together.
Your net cash flow from the cash flow statement can help you in your quest to increase your net worth. You can apply the money to acquiring assets or paying off liabilities if you have a positive net cash flow in a given period. Applying your net cash flow toward your net worth is a great way to increase assets without increasing liabilities or to decrease liabilities without increasing assets.
What Are Some Examples of Non-Liquid Assets?
Non-liquid assets are those that you can't sell or dispose of quickly if you need cash. Real estate, automobiles, artwork, and jewelry are all non-liquid assets. They can also lose value in the sales process. You might purchase your home for $350,000 and then have to sell it for only $300,000 if you find yourself in an emergency where you have to liquidate assets as quickly as possible to raise cash.
How Much Does the Average American Spend a Year?
The U.S. Bureau of Labor Statistics reported in September 2023 that average annual expenditures per household were $72,967 in 2022. This was up 9% from the year before. Average income before taxes increased only 7.5% during the same timeframe.
How Much Money Should I Have in Savings?
It's been said that you should save six months' worth of living expenses tucked away but the U.S. Securities and Exchange Commission puts a slightly different spin on that. It says you should have six months' worth of income saved. That works out to $30,000 if you earn $60,000 a year.
The SEC also suggests that you might want to consider paying off your high-interest credit card debt to amass some savings rather than invest your money, hoping to earn some. You might find that the amount you're saving on interest is more than a safe investment such as a money market or mutual fund would pay you in a given period.
The Bottom Line
Approach your finances like a financial advisor during your annual review. If you have a negative cash flow or you want to increase positive net cash flow, the only way to do it is to assess your spending habits and adjust them as necessary. You'll be well on your way to greater financial security if you use your personal financial statements to become more aware of your spending habits and your net worth.
