A couple of weeks ago we read about what is your financial net worth. How do you increase your financial net worth? One way is to have consistent net profit.
If you are a business owner or self-employed you know what a profit and loss, (P&L) report is. It’s your revenue (income) minus expenses (deductions).
Before you tune out thinking this doesn’t apply if you aren’t a business owner, stop and think about your personal finances. Do you have income of some sort? Do you have expenses of some kind that income is used to pay for?
Then while you may not have a business P&L, you most certainly do have a personal profit and loss and if you consistently run your personal life at a net profit (make more than you spend, or spend less than you make), over time your net worth should grow.
If you work and you earn money or have some sort of income, then I would submit that you are in business and your business is you.
Business owners know that they need to be aware of their P&L. They need to be aware of their balance sheet. We talked about that a couple of weeks ago in the net worth article, go back and reread that if you missed it.
Your personal life has a financial statement just as much as a business does and your long-term financial health is dependent upon knowing your personal financial statement and how your decisions influence it.
But what goes on a profit and loss report? On the income side it’s pretty simple, income. Maybe it’s wages you earn, investment income coming directly to you, perhaps you get some sort of assistance income, but it’s still income.
Expenses might not be so obvious. Not all cash outflows are an expense, although they are the result of an expense. I’m talking about using credit cards. The expense happens when you charge something on a credit card, not when you pay the credit card. Paying a credit card is a cash out flow yes, but not the actual expense.
Here is an example to illustrate. Let’s say you make $40,000 per year take home after payroll tax deductions. You have other expenses that you need to pay from your checking account directly that add up to $25,000. So, all else being equal you have a net profit in your personal life of $15,000, pretty nice.
But wait there’s more. Now let’s assume that in addition to the $25,000 of expenses that had to be paid from your checking account where your paycheck was deposited, you used credit cards and charged $10,000 more to buy the latest gadget or shiny new thing that everyone else has yet you only made $2,000 in minimum credit card payments. What’s your net profit now?
You only made $2,000 in credit card payments so is your additional expense only $2,000 or is it $10,000?
Eventually you must pay that remaining $8,000 to the credit card company (plus interest) whether in full or in payments so if you were to look at your personal finances you really now only have $5,000 in net profit.
I’m not saying don’t use credit cards, but I am saying don’t be lulled into false sense of security that simply looking at your bank account balance is a measure of how well you are doing. You can buy lots of stuff and not yet have paid for it so still be broke even with money in the bank.
How do you track your spending? You can run your own personal finances and monitor it as if you're a business. There's lots of software out there to help with that. Being a financial adviser and a CPA accounting and tax geek personally I prefer QuickBooks, and more specifically QuickBooks Desktop.
I realize that doesn't work for everybody and if it’s not something you will use then its worthless.
You could get QuickBooks Online and set up yourself up as if you were a business with your own bank and credit card accounts and track your profit and losses.
You could buy something that's more consumer oriented like Quicken and you do the same thing. You link in your bank and your credit card accounts and make sure you have strong passwords that you update often.
You then update your records regularly, at least monthly and put a reminder in your calendar to do that and then – review your results.
Don’t just do updates, but also review your results and monitor your improved finances as you watch your net worth grow.
You might be surprised to see what you consider to be small expenses actually be much larger expenses when they are added together over a period of time.
If you don't like the financial results that you're seeing, if your profit and loss is not something you're proud of, then it's time to start taking action. Maybe work with somebody you trust for an accountability partner or work with your financial advisor. It could be that it’s a combination of trimming expenses and growing your income.
Over time monitoring your personal financial statement becomes routine and may actually give you more financial freedom and not be as restrictive as it seems once you can identify wasteful expenses and redirect them to more productive uses of your income.
As always when you are ready to meet lets set up a call.