The big 3 statements
The big 3 of the finance world. These three financial statements will tell you where you are, where you're going and how you're doing. Essentially all you need!
Managing your personal finances is a lot like sailing a pirate ship. You need tools like a Windrose compass to navigate through the seas successfully. These tools, in the world of personal finance, are your financial statements. Let's dive into the world of financial statements and see how they can help you track your wealth effectively.
Understanding financial statements
Financial statements are snapshots of your financial health at a specific point in time. They provide a comprehensive overview of your financial situation, helping you make informed decisions, set financial goals, and track your progress over time. The big 3 financial statements to :
1. The balance sheet (A snapshot of your wealth)
The balance sheet is like a photograph of your finances, capturing everything you own (assets) and everything you owe (liabilities) at a point in time. It consists of two sections:
Assets: These are what you own, including your savings, investments, real estate, and personal property.
Liabilities: These are what you owe, such as mortgages, student loans, credit card debt, and other outstanding loans.
Knowing your assets and liabilities will allow you to calculate your net worth, which is a fundamental indicator of your financial health and helps you understand where you stand. To calculate your net worth, subtract your total liabilities from your total assets.
Net worth = Total assets - Total liabilities
Regularly update your balance sheet to see how your net worth evolves over time. This document serves as a benchmark to assess your financial progress and helps you determine where to allocate your resources.
2. The income statement (Your financial compass)
The income statement, also known as the profit and loss statement, tracks your financial performance over a specific period, typically monthly, quarterly, or annually. It helps you answer questions like, "Am I living within my means?" and "How much am I saving?" It should show your:
Income: Your earnings from various sources, such as salary, investments, rental income, or side hustles.
Expenses: Your spending, categorized into essentials (like rent or mortgage, groceries) and non-essentials (like dining out, entertainment).
Once you know your income and expenses you can calculate your savings.
Savings = Total income - Total expenses
Your income statement is your financial compass, guiding your ship towards your financial goals and showing where you might need to adjust your course. Regularly review your income and expenses to ensure you're living within your means and making progress towards your savings goals. It's a practical tool to fine-tune your budget and optimize your financial strategy.
3. The cash flow statement (monitoring your liquidity)
The cash flow statement is all about the money coming in and going out. It provides a detailed breakdown of your cash transactions, helping you understand how you manage your liquidity. It's usually divided into three categories:
Operating activities: Income and expenses related to your day-to-day life.
Investing activities: Transactions related to buying and selling assets like stocks, real estate, or other investments.
Financing activities: Money movement associated with borrowing or repaying debt.
Monitoring your cash flow statement helps you ensure you have enough cash to meet your short-term financial needs while working towards long-term financial goals. It's crucial for assessing your ability to cover bills and invest for the future. Though, I wouldn't loose sleep if you didn't track it. I think it's a nice to have if you get deep into tracking your personal finances, personally I don't track this as closely.
Using financial statements to track your wealth
Now that you know the basics of these financial statements, let's see how they work together to help you track your wealth:
Start with your balance sheet: Calculate your net worth regularly. As you make progress in paying down debts and accumulating assets, you'll see your net worth grow which is a great thing!
Monitor your income statement: Review your income and expenses to ensure you're living within your means, saving, and investing in line with your financial goals. Making sure your spending habits are adjusting if needed.
Cash flow analysis: Use your cash flow statement to understand your short-term financial liquidity.
By regularly updating and analyzing your financial statements, you gain clarity on your financial situation and can make strategic decisions that align with your goals. Tracking your wealth becomes a structured and manageable exercise, letting you to take charge of your financial future.
Given financial well-being is crucial, mastering the art of your personal financial statements can make a significant difference in achieving your financial dreams. So, start today and leverage these tools to track your wealth and secure your financial future.