No corporation can last very long if it mismanages its finances or loses control of them. One of the prime examples of this is the corporation Enron whose sales increased from $13.3 billion to $100.8 billion between 1996 and 2000. The company’s stock hit a high of $90.75 per share in mid-2000 but then plummeted to less than $1 by the end of 2001. It ended up filing for bankruptcy on December 2, 2001 despite the fact that it had $63.4 billion in assets.
While you might not have ever thought of your family finances as a corporation you do need to give them the same attention to details as would a corporation’s accounting department or chief financial officer.
We do understand that taking a formalized approach to organizing all of your family’s financial information can seem intimidating or even confusing but there are things you could do to break it down into more bite-size chunks. And here are three ways to do this.
Determine your net worth
A corporation uses a balance sheet to keep track of its assets or those things that it owns as well as its liabilities, which are known as debt. When you subtract your debt from what you own or your assets a corporation would call this “shareholder’s equity.” But in your case, this would be your net worth. If your net worth is positive and growing this means your family is in a healthy financial situation. On the other hand, if your net worth is negative or shrinking this could suggest there’s trouble ahead.
How net worth changes
Young people who are just on their way to building a family could find themselves in a temporary time of either flat or falling net worth. According to an article from CNN.com 40 million Americans have at least one student loan debt – most of them are Millennials. But that’s okay. If they put together a prudent financial plan this would help them transition through this phase where they have higher debt than assets. Plus, it’s reasonably certain that they will earn more in the future and see their net worth increase accordingly.
For that matter, keeping track of the difference between your debts and assets can be a simple way to know your family finances. It can also be particularly useful over a period of time as this would allow you to see if things are either improving or not.
Here’s a simple example of how net worth works. Suppose you bought a new car and financed 100% of its cost. For the sake of the example, we’ll assume it’s a Mazda 3 at a cost of $17,000. The impact this would have on your family’s net worth will be neutral. You have a debt of $17,000 but it’ would be offset by a new $17,000 asset. Of course, over time this will shift as the value of the car declines as does the amount you owe.
An income statement
If you were a corporation your income statement would be where your chief financial officer accounts for all the revenue coming into the business versus all the expenses required to run it. The analogy to this in your family finances would be your salary or self-employment and earnings, which would be on the income side of your statement. All of your debts would naturally be on the expense side. This might actually look a lot like a budget.
Your household income statement will be the same as a corporation’s balance sheet in that it will change over time and probably go through phases. As an example of this, a college student will have very low expenses. In comparison, a family would likely have a car payment, a mortgage, groceries, utility costs, insurance and a myriad of other costs – in short, much higher expenses. However, over the long run your income statement should show a slow and steady build to your prime earning years, which will likely be in your 50s. After this, your income statement may change dramatically as your expenses decrease and you prepare for retirement.
Net worth and an income statement are two of the big three or the three most important areas of business accounting. The third is cash flows.
Cash flow is just the actual money you can track. It overlaps somewhat with your income statement and has elements of a budget. However, it captures important information directly from your income statement and may provide you with a much better view of your family’s financial health then your net worth number.
What cash flow represents is money in and out of your bank account that could at least theoretically be spent on something. In comparison, a cash flow is not physical dollars. As an example of this suppose your house increases in value so your balance sheet would show that as a larger asset but, of course, no cash would actually change hands unless you sell the house. The net you/net of this is that your net worth number could shift but not your statement of cash flows. Here’s another example of how this works. Let’s say that you were to buy a car but instead of financing the whole thing you put $5000 down and then financed $12,000. Your statement of cash flows would capture both the outflow or amount of money that went for the down payment and any payments and your financing. However, your net worth would not change as the change in assets and liabilities would offset each other.
Get some tools
If all of this sounds a bit complicated it can be simplified. We live in the age of apps and there are many options available for tracking your spending and analyzing your personal finances – on the web or via your smartphone. Two of the most popular of these are the free Mint.com and its paid cousin at Quicken.com. There are also some good alternatives such as Blueleaf.com that you could use if you have a relationship with a financial advisor that participates in the program.
However, all that most households really need is just a spreadsheet like Google Sheets. This can be particularly true if your bank and credit card company offer the ability to export or download your activity reports in a spreadsheet format. You as the household CFO could spend a little time customizing that data and then do some pretty serious organization and tracking of your family’s income versus expenses, network and cash flow accounting. And once you get all this information organized you’ll have your finances under control, you’ll know exactly how you stand and you won’t have to worry about ever becoming an Enron.
If you’d like to know how to set up a family budget as a precursor to determining your net worth, etc., here’s a short video that will help.