First things first, I’m not an accountant and I don’t claim to know the wizardry they employ to protect us, grow our business wealth or maximise tax. However, my work does mean that I see and take a lot of learnings from financial statements. These statements can be your most valuable diagnostic tool when it comes to business, so I began to wonder, why is it any different for an individual? Spoiler alert: it shouldn’t be and I’m breaking down why.
So what on earth are these statements and why are they important?
- Profit and loss: a statement for your business income and expenses for a period. Don’t forget that ‘for a period’ part. These statements cover 3 months, 12 months, year-to-date or a period where you earn revenue or income, pay expenses and try to make that profit (after tax…yikes). This statement focuses your attention on the current day-to-day drama, the period it is in, and the tweaks you need to make tweak achieve a greater result. It’s a short term statement which will help you:
- Track earnings, expenses & profit
- Measure your profitability
- Adjust and reap the benefits quickly
- Balance Sheet: a statement on your assets (things that hold value), liabilities (debts or obligations) and equity (the difference between the first two or what you own at the end). Businesses will usually find bank balances, equipment, property, short term loans, long term loans and then some on this statement. The key here is that it’s a snapshot or a point in time reference for your business that happens over time. This guy is in it for the long run. It’s a culmination of your hard profits summaries into what you have achieved with it, beyond what you pay yourself personally. This is important to:
- Track assets, liabilities and equity (your net position)
- Review your overall net worth
- Review and understand risk
- Help with your long term critical thinking
- Cashflow: a statement that I rarely see produced, however, in my opinion is the most important. It’s the statement that tracks your profit and loss and then translates to the movements in your balance sheet. For now, let’s leave this one out of it, although there will be more content coming. In the meantime repeat after me: cashflow is KING.
Now we have the theory down, how do I implement it as an individual?
You don’t need me to tell you the power of a budget. We love to make them, try and stick to them and sometimes bin them. I too have a love hate relationship with them! But as an individual, your budget is your profit and loss, your ins and outs over the month, 6 months or year you chose to track it. For those who work and have tax taken out of their pay, your profit and loss is essentially your cashflow and is generally where we focus our efforts. You change banks, review insurance, cut down on your beloved Uber eats (*cries*).
What about your personal balance sheet? This is your savings, car, super loans, credit cards and any other debts (mortgage anyone?). How often do you really track these? You may know the values but have you tracked them year on year? I bet, like most, you do on the odd occasion but thinking critically about your balance sheet is a long term game. It’s the most important. In finance you are taught that a strong balance sheet provides the backbone for a healthy business. It can help you sustain all business dramas, liquid funds (cash to pay for things), long term growth assets (property, machinery, shares) and this is the same for an individual. For me the fundamentals of my balance is based around property, and as I get more seasoned I think about how risky that is, how diverse my assets are, how much debt I have associated against this and what it may look like in 10 or 20 years when I stop working and my profit and loss has declining income (hopefully by my choice to retire).
So WHAT? You say.
Managing your profit and loss and balance sheets is as critical for an individual as it is for a business owner. I’m not saying you need all the fancy graphs, formulas and reporting around it, but the concept holds true. Manage your profit and loss and translate that into a strong balance sheet. Learn like business owners do to adjust short term for the benefit in the long term, and think about the assets that will help you get there. And yes, I have a bias towards property assets.
Not sure where to start? Want a copy of a budget and personal balance sheet? Get in touch and I will send help. No graphs (yet), I promise.