Evaluating Your Financial Position
A personal balance sheet helps you measure progress toward financial goals. Your financial situation improves if your net worth increases each time you prepare a balance sheet. It will improve more rapidly if you are able to set aside money each month for savings and investments.
As with net worth, the relationship among various balance sheet items can give an indication of your financial position. The Financial Planning Calculations box on the next page explains several commonly used financial ratios.
The Cash Flow Statement:
Where Did Your Money Go?
Each day, financial events can affect your net worth. When you receive a paycheck or pay living expenses, your total assets and liabilities change. Cash flow is the actual inflow and outflow of cash during a given time period. Income from employment will probably represent your most important cash inflow; however, other income, such as interest earned on a savings account, should also be considered. In contrast, payments for items such as rent, food. and loans are cash outflows.
A cash flow statement, also called a personal income and expenditure statement, is a summary of cash receipts and payments for a given period, such as a month or a year. This report provides data on your income and spending patterns, which will be helpful when preparing a budget. A checking account can provide information for your cash flow statement. Deposits to the account are your inflows; checks written are your outflows. Of course, in using this system, when you do not deposit the entire amounts received. you must also note the spending of undeposited amounts in your cash flow statement.
The process for preparing a cash flow statement is
Total cash received during the time period - Cash outflows during the time period = Cash surplus or deficit
Step 1: Record Income Creating a cash flow statement starts with identifying the cash received during the time peliod involved. Income is the inflows of cash for an individual or a household. For most people, the main source of income is money received from a job. Other common income sources include
- Wages, salaries, and commissions. Self-employment business income.
- Saving and investment income (interest, dividends, rent}
- Gifts, grants, scholarships, and educational loans.
- Government payments, such as Social Security, public assistance, and unemployment benefits.
- Amounts received from pension and retirement programs.
- Alimony and child support payments.
Take-home pay, also called net pay is a person's earnings after deductions for taxes and other items. Lin's deductions for federal, state, and Social Security taxes are $1,250. Her take-home pay is $3,196. This amount, plus earnings from savings an investments, is the income she has available for use during the current month.
Take-home pay is also called disposable income, the amount a person or househo.~ has available to spend. Discretionary income is money left over after paying for housing, food, and other necessities. Studies report that discretionary income ranges fro less than 5 percent for people under age 25 to more than 40 percent for older people.
Step 2: Record Cash Outflows Cash payments for living expenses another items make up the second component of a cash flow statement. Lin Ye divides h cash outflows into two major categories: fixed expenses and variable expenses. While every individual and household has different cash outflows, these main categories along with the subgroupings Lin uses, can be adapted to most situations.
1. Fixed expenses are payments that do not vary from month to month. Rent or mongage payments, installment loan payments, cable television service fees, and a month]. train ticket for commuting to work are examples of constant or fixed cash outflows.
For Lin, another type of fixed expense is the amount she sets aside each month f, payments due once or twice a year. For example, Lin pays $384 every March for lit insurance. Each month, she records a fixed outflow of $32 for deposit in a special sa\ings account so that the money will be available when her insurance payment is due.
2. Variable expenses are flexible payments that change from month to month. Common examples of variable cash outflows are food, clothing, utilities (such as electricity and telephone), recreation, medical expenses, gifts, and donations. The use of a checkbook or some other recordkeeping system is necessary for an accurate total of cast outflows.
Step 3: Determine Net Cash Flow The difference betweer: income and outflows can be either a positive (surplus) or a negative (deficit) cash flow. A deficit exists if more cash goes out than comes in during a giver: month. This amount must be made up by withdrawals from savings or by borrowing.
When you have a cash surplus, as Lin did, this amount is available for saving, investing, or paying off debts. Each month, Lin sets aside money for her emergency fund in a savings account that she would use for unexpected expenses or to pay living costs if she did not receive her salary. She deposits the rest of the surplus in savings and investment plans that have two purposes. The first is the achievement of short-term and intermediate financial goals, such as a new car, a vacation, or reenrollment in school; the second is long-term financial security-her retirement.
