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This is the first segment in a series of articles designed to help you assess your financial situation and begin building your wealth.
I want this series to be an interactive workshop, so as we go along I will not only be providing valuable information, but will also provide assignments along the way to help you put this information to practical use in your own life.
I hope you will join me for the entire series.
How do we build wealth? Well, as I like to say, the numbers tell the story.
When it comes to numbers, businesses use many measurements to determine their financial health, but the three main things that they look at the most are their Balance Sheet, their Income Statement, and their Statement of Cash Flows.
A balance sheet in the personal finance world is often called "net worth".
It looks at an individual's financial position at a given point in time.
Think of it as a financial snapshot for a given date.
Businesses typically look at their balance sheet on a quarterly and annual basis, but in personal finance it's probably more practical to stick with annual.
The formula for determining net worth is very simple: Assets - Liabilities = Net Worth.
Assets are things that you own of value that, in theory, could be liquidated (sold) to produce cash to pay off your liabilities.
Liabilities are things that you owe money on such as cars, homes, credit cards, etc.
When you calculate your net worth, if you would theoretically be able to liquidate your assets and with the proceeds pay off all your liabilities, then any money left would be your net worth.
Amazingly, many folks actually have a negative net worth.
An income statement is something that is measured over a period of time (vs.
a discrete point in time as with the balance sheet) and it measures how profitable your business is.
It helps to look at the income statement on a monthly basis.
The formula for that is just as simple: Income - Expenses = Net Income.
If your net income is consistently positive then you are in good shape.
If it's consistently negative, then you have some hard decisions to make! The Statement of Cash Flows is a bit more complicated and, frankly, is where many people fail with their finances.
This basically measures income and expenditures on an ongoing basis.
It tells you how well you will be able to meet your financial obligations.
If you are not watching your cash flow carefully you could still get into financial trouble even if you technically have a positive net income for the month! For example, if your mortgage is due the first of the month and you don't have cash in your bank account to pay for it because you don't get paid till the 15th of the month, then you have a cash flow problem.
Many people fall into the trap of not managing their cash flow and pay for it dearly in the form of late payment penalties and additional interest.
Left unchecked, these things will eventually impact your income statement and ultimately cause your net worth to go down the tubes.
The true secret to building wealth is to be obsessive about keeping an eye on these three measurements.
I will deal with these more later on in the series.
One thing that is extremely helpful is to purchase (and use!) one of the many personal finance software applications on the market today.
I'm not advocating any particular one - you need to decide which on is better for you.
I believe Quicken (produced by Intuit) and Money (produced by Microsoft) are the leaders in the industry, but there are many others out there that may be better and cheaper.
Assignment: Review the three measurements we've discussed in this post and see if you can put together a Balance Sheet and Income Statement for your own personal situation.
See where you stand.
Is either of them showing negative numbers? If so, then we have some work to do! In the next segment we will be discussing budgeting.
I hope you will join me for this!
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