Understanding Personal Financial Statements: a Key Skill for Effective Planning

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The best way to make the most of your money is to understand how you earn, spend and save. One of the best tools for this is a personal financial statement listing all the relevant information. If you’ve never done it, creating, reading and understanding a personal financial statement can seem like a big challenge.

In reality, it’s really not that difficult, and it’s one of the most essential skills you can apply to managing your personal finances. Keep reading to learn more about personal financial statements, including a step-by-step guide and some tips on how to best use the information you’ll be collecting.

What Are Financial Statements?

The simplest way to understand financial statements is to see them as a report card for your specific financial situation.

Personal financial statements will generally be broken down into a balance sheet and an income statement. Reviewing that information lets you learn what to expect of your financial health, meaning where you stand financially.

Doing this will not only help you keep track of debt, savings and other financial goals, but it will also give you a solid basis to plan for the future.

The Balance Sheet

Typically, your balance sheet is made up of three parts: assets, liabilities and net worth.

Assets

• Liquid cash and cash equivalents: Here, you’ll list all the money you can access quickly. You’ll want to include things like the amount you have in checking and savings accounts and any short-term investments you can easily convert to cash if needed.
• Investments: If you have long-term investments like stocks, mutual funds, bonds and/or a 401(k) account you might have through an employer, you’ll want to record that under this heading.
• Property: This doesn’t just mean a house or the land it’s on but can also include things like your car and how much you would realistically be able to sell it for. Though you wouldn’t want to have to convert these assets to cash, understanding where your money goes means knowing what you’re paying — or have already paid — for.
• Other assets: Anything else you own that would be considered valuable would go here. This could be anything from art or valuable coin or card collections to things like jewelry and other belongings with a high resale value. You don’t need to list everything, but anything that represents a high price tag should go here.

Liabilities

• Short-term liabilities: Anything you’re making monthly payments on and could conceivably pay — or is due to be paid in full — within a year of creating your financial statement should go here. This would be things with regularly recurring payments like subscription services or gym memberships.
• Long-term liabilities: These are generally high-end items like a home mortgage, car payment and loans, including student loans, that will take you more than a year to pay off entirely.
• Earnings: This is the amount you make from your job, whether wages or salary, and predictable work-related income like annual bonuses.

Net Worth

At the bottom of your balance sheet, you’ll want to put your net worth. This is the amount left over after subtracting your liabilities from your assets. Expressed as a formula, it would be “assets – liabilities = total net worth.”

If this turns out to be a negative number, don’t panic (and you’re not alone). Remember, the goal here is to understand your finances so you can plan more effectively.

Income Statement

An income statement can be divided into three parts as well: income, expenses and net income.

Income

• Investment income: If you have investments that regularly pay you money, those go here. That doesn’t just mean stock dividends but also includes the interest you earn on bank accounts and capital gains from the sale of investments.
• Other income: Any source of income that doesn’t fit in the above two categories would go here. This includes federal benefits, child support, alimony or rental income.

Expenses

• Fixed expenses: Any predictable, regular payment for necessities like rent, insurance premiums and other expenses you wouldn’t be able to easily change would go here.
• Variable expenses: These costs might change from month to month, like transportation, groceries and things like dining out or entertainment.
• Savings and investments: If you set aside money for savings each month or contribute a set amount to an investment portfolio, those expenses would be listed here.

Net Income

Much like your net worth, your net income is the amount left over after subtracting your expenses from your income. If this is a negative number, you’ll need to see where you can make changes to be sure you’ll be able to cover the necessities. The formula for this would be “income – expenses = net income.”

Your Personal Financial Statement: a Step-by-Step Guide

Now that you have a better understanding of what goes into your financial statement, here are steps you can take to create your own.

1. Gather Your Financial Documents

You’ll need to get all those numbers from somewhere. Gather your financial information from bank and credit card statements, investment accounts, loan agreements and anything else that lists financial data.

2. List all Assets and Liabilities

Start with your balance sheet and go down the list above, plugging in numbers. List assets, including their market value, and how much you owe in liabilities with brief descriptions.

3. Calculate Your Net Worth

After subtracting your liabilities from your assets, you’ll know where you stand and can decide how you want — or need — to allocate your resources.

4. Track Income and Expenses

Once you’ve done the above steps, list all your sources of income and your expenses broken down by category. This will help you understand where your money comes from and how you’re spending it.

5. Review and Adjust

Next, review your net income. If it’s negative, you’ll need to find a way to cut expenses or increase income. If you’re making more money than you’re spending, review your assets and liabilities. See if there are any debts you can pay down more quickly or if you have any investments or interest-bearing accounts you can allocate more money toward.

Planning Using Your Personal Financial Statement

Your personal financial statement is a great tool for long-term planning and setting reasonable, achievable financial goals.

You can use it to see where you might be overspending or to find opportunities to save more. You can even use this financial statement to help you set long-term goals such as funding your retirement accounts, purchasing a home or saving for college tuition.

One of the most useful things you can do is to set aside money for an emergency fund that could cover all of your expenses for several months if something unexpected should happen, like the loss of a job or expensive car repairs.

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