You Should Create A Balance Sheet To Analyze Your Personal Finance

Common Sense Personal Finance

You should occasionally do a balance sheet for your personal finance in order to keep track of your money. Here's are the things you need to do:

1. Split your assets into five different categories

• cash and equivalents
• short term investments
• long term investments
• equity (money you have but can't touch until you sell)
• other property (these have values, but they are not liquid)

2. Figure out your liabilities (debts) and divide that into three different categories

• short term debt
• long term debt
• future debt

From the assets and liabilities, you can calculate your net worth, which is assets minus liabilities. The first thing to look for is whether your total assets is higher than your liabilities. The higher your assets relative to your liabilities the better. If your assets is about equal to your liabilities, then that's not very good because your net worth is essentially zero. I personally like to have my liabilities to be 1/3 to 1/2 of my total assets. In other words, the assets should be 2 or 3 times more than your liabilities.

The other thing that I look at is whether my short term assets can cover my short term debts. The stuff that are held in long term accounts can't be liquidated quickly enough to cover my short term debts. For example, if I know that I need to pay a bill of 20k. I make sure that I have enough short term assets that I can liquidate to cover the 20k debt. If there is not enough short term assets, then I shift money from the long term assets into short term assets.

The assets that are tied up in equity and in property are useless money. It's good to know what the values are, but in terms of normal operational money, those money don't come into play.

The next thing to do is to look at your cash flow. This is your income and expenditures. For income, it is important to look at future income. If your future income is going to go up, then of course that is good news, but your future income can also decrease. It is important that you evaluate those future income accurately to reflect your situation. For your expenditures, you can also divide that into short term expenditures and long term expenditures. Long term expenditures are spread out for many years like a mortgage.

Generally, what you want to do is to shift more of your expenditures to long term expenditures. You should have a low percentage of short term expenses. These are generally the impulse buys and necessities. Overall, the income should be higher than your expenses. Housing expenses should be no more than 1/3 of your income. Your overall expenses should be 2/3 of your income. That will give you a 33% savings rate. For many people, however, the expense/income ratio is very high, which push the savings rate to practically zero. That's not very healthy. You should try to reduce the expenses in that case in order to try to bring down your expense/income ratio.

Creating a balance sheet should be your first step in taking back control of your finances.