Personal finance can become tricky to handle, especially when you are not from “commerce” background. Not knowing basics of personal finance such as terms like balance sheet, cash flow etc. can really slow your finance game.
Are you from “science” or “humanities” background? Do you remember making fun of your commerce wale friends when they used to pull their hair out in frustration when their balance sheets don’t used to match?
School days were good days man!
Okay, enough nostalgia for today!
People often struggle to manage their finances by themselves because they do not know how to do it. People are usually unaware of the basic terminologies personal finance comes with.
This article by Bachat aims to make you understand the role of different concepts like a balance sheet; cash flow etc. in managing your personal finance.
Also, before you transfer the responsibility of managing your finances to a professional finance planner, read this: How You Can Create a Financial Plan without an Expert’s Advice
- 1 Learning Personal Finance: The Process
- 2 The Ultimate Objective
- 3 Basics of Personal Finance #1: Balance Sheet
- 4 Basics of Personal Finance #2: Investments
- 5 Basics of Personal Finance #3: Insurance
- 6 Basics of Personal Finance #4: Cash Flow
- 7 Personal Finance Term #5: Budgeting
- 8 50/30/20
- 9 80/20
- 10 Envelope technique
- 11 Budgeting applications
- 12 Conclusion
Learning Personal Finance: The Process
So let’s begin.
Before jumping straight into the technicalities, let me tell you that these are the five concepts we will be covering in the managing of personal finance:
- Balance Sheet
- Cash Flow
Using the above five processes, we have to aim for our ultimate objective.
The Ultimate Objective
So what is our ultimate objective?
Err…to manage personal finance? This is what you thought, right?
Yes, you are right.
But what are we aiming to strive by managing personal finance?
Building our net worth.
But what will net worth do?
It is our net worth that will finance our goals in life. It is the net worth which makes one ‘wealthy’ or ‘middle-class’.
Therefore, net worth needs to be built.
Let’s move on to our first concept for the day.
Basics of Personal Finance #1: Balance Sheet
First things first: what is a balance sheet?
It is a record of one’s assets and liabilities accumulated over time.
To put it into layman’s terms, assets are basically those things which either add to your income, or at least don’t eat away your existing income.
Whereas, liabilities are those things which sort of eat away your earnings in one way or another.
So, naturally, our target is to purchase more assets and lesser liabilities.
Before proceeding further, let me state the formula for net worth:
Net Worth = Assets – Liabilities
Preparing a balance sheet is very important and should be your first step when proceeding towards managing your personal finance.
A balance sheet will show you:
- Market value of your assets
- Market value of your liabilities
Also, normally a balance sheet has two columns: Assets and Liabilities.
But I prefer a third column as well: Goals.
Adding goals to your balance sheet will let you know how much investment you are falling short of for a particular goal.
Basics of Personal Finance #2: Investments
The assets section of your balance sheet should be nourished with investments. Investments which show significant growth.
Your investments should mostly reflect long-term investments.
For more on investments, read 7 Investment Tips For You
It doesn’t matter how less you invest, what matters is that you start investing. Your investments will help you to convert your ‘salary’ into ‘wealth’.
To explain to you the power of investing, let me borrow some lines from: Financial Tips for 2019 for Indian Millennial
Did you know that if you save Rs. 1 Lakh every year for the next 30 years with no interest, you would have a corpus of Rs. 30 Lakh after those 30 years?
However if you invest that same Rs. 1 Lakh a year in an investment vehicle that fetches you a return of 10% per annum, you would be sitting on a corpus of a whopping Rs. 6.97 crores!
Do you see the difference?
It’s called the magic of compounding! Your interest earns interest and its interest earns interest and so on!
As we just calculated, the result is exponential growth.
To make your money grow, you need to make it work for you (most important principle of personal finance) And the easiest way to do so is by investing it!
Basics of Personal Finance #3: Insurance
Collecting funds seems all fun until you hit a financial disaster and stand to lose all of it. Therefore, personal finance is not only about collecting funds, but also protecting them.
Insurance is probably the only thing you will pay for but would dread using.
It is important you take out some time to analyze your existing policies and consider getting new policies, if required.
Therefore, to avoid drowning in this money-trap of insurance policies, it is essential that you analyze each and every pointer of each policy and then proceed further.
Basics of Personal Finance #4: Cash Flow
Analyzing your cash flow while managing your personal finance is an essential activity.
You must know where your cash ends up at the end of the month.
Both inflows and outflows should be accounted for.
When you’ll subtract your outflows from your inflows, you’ll arrive at your savings. This is the money you can use for investments.
Higher the savings, higher the investments, higher the gains.
Personal Finance Term #5: Budgeting
A month to month budget gives you authorization to burn through cash whenever you need to. By taking the time to make a budget, you can make your life simpler.
Basically you shouldn’t spend more than you make every month. You need to make sense of what works best for you and your money related objectives and then draft a budget intelligently. There are a variety of methods for budgeting which you can choose from:
To keep a track of your salary every month, utilize the 50/20/30 guideline for your spending planning.
The 50/20/30 rule offers a fundamental budgetary system for your spending and sparing. The standard says that you ought to burn through half of your pay on your everyday costs.
According to this guideline, you should invest 20% of your salary in investment funds and make provisions for savings. You can utilize the rest 30% for recreational activities without worrying about a cash crunch.
Since the 50/20/30 standard is just a guideline, there is some adaptability.
You can change the specific portions dependent on your individual circumstances and preferences.
The fundamental thought is to confine your everyday costs to generally half of your pay. That way, you’ll have enough remaining for your savings and recreation.
An easier variant of the 50/30/20 strategy is the 80/20 spending plan, which simply has you take 20% of your salary to put towards investment funds and freely spend the rest.
You can change the ratio to suit your personal needs. However, this method is not suitable for beginners because of its vague nature.
On the off chance that divisions aren’t generally your thing, there is likewise a system called the envelope technique. Name envelopes with certain cost classes like rent, utilities, groceries, eating out, amusement, investment funds. The thought is to physically put aside the cash you will spend in every classification.
There is an app for pretty much everything, and budgeting is no exemption.
You can get the Bachat app that will help you make automatic savings and what’s more, it will even reward you for your savings.
The Bachat app transfers a fixed proportion of your monthly income to a particular savings account for you.
I hope the above concepts will get you through your finance management crisis. Balance sheet, investments, insurance, cash flow statements and budgeting are all equally important in this process.
Save more to earn more since money earns money.
Keep following Bachat for more such informative blogs. It’s one of the most popular Indian personal finance blogs after all!