When we last visited I outlined some of the basic principles that need attention to more effectively chart our financial course in life. The start of any journey requires proper preparation, and that’s what ‘the beginning’ is all about. Today we’ll revisit briefly those concepts, put the pieces together and look at another exercise for the parents among us.
The four elements of financial living we’ve looked at are:
- What we have already
- What we owe
- What we earn
- What we spend
Knowing what we have and what we owe allows us to create a Balance Sheet. Our assets (what we have already) minus our liabilities (what we owe) show us our Net Worth. Understanding what we earn and what we spend allows us to create an Income Statement. Our income (what we earn) minus our expenses and other debt payments (what we spend) show us our Net Income. Each is a point in time snapshot of the key elements of our financial health. Ideally, over time our Net Worth grows and our Income Statement never goes negative, or ‘into the red’.
While both an accurate Balance Sheet and Income Statement are elementary tools, it’s surprising how few can produce either when asked. For those who handle their finances manually, the task of creating an Income Statement should be undertaken once a month. A Balance Sheet should be updated at least quarterly. Both should be maintained with your other financial records. Since family finances are a ‘team sport’ it is important for both spouses to review these documents, and it’s even better if both participate in creating them. Also, if there are children, these are worth sharing in an age appropriate way. Our children need to understand how money works. It’s vital to their better future.
As an alternative for doing this work manually, I’m a big believer in Quicken or other similar software programs that are available at a nominal cost. My family tracks EVERYTHING in Quicken, even logging cash expenditures and others at a very detailed level. At first, it was tedious and seemed overly time consuming, but today it’s become something we look forward to doing as we chart our progress forward. And it’s even paid us back, by allowing us to fully maximize our deductions at tax time and in a host of other ways.
Next, let’s look at the concept of budgeting. For many this is a ‘dirty word’, a subject we’d rather avoid. After all, a budget is all about saying ‘no’, isn’t it? Well actually, a budget is our opportunity to tell our money what we want it to do for us – – nothing more or less – – through our spending. A budget is closely related to the Income Statement and will positively or negatively impact the Balance Sheet.
In my work with families, very, very few have a written budget. Most say that they ‘track things in their head’ and that they ‘have a pretty good handle on their spending’. In my first article I suggested an interesting month long exercise for a family. That was to track by week ALL financial transactions – cash, checks, credit card purchases, automatic debits, ATM transactions and so forth, for a month. Invariably, I’ve found that when a family will do this the see perhaps for the first time the reality of what they are spending . . . and that is almost always VERY different than what they’ve been ‘tracking in their heads’. While painful, completing this exercise flushes out all the areas a family is spending money, and how much is being spent in each area. When this is listed, categorized and summarized, at the end of a month, you have the start of a real budget AND you’ll also see in black and white several categories of spending where you’d like your money to do something else entirely (smile). This real data can be the basis for productive family discussions about your financial goals and objectives as a family.
A last note on budgeting is worth mentioning. Budgets are dynamic, not static. What I mean is that a budget should be used as a FLEXIBLE framework for planning our spending. It SHOULD change as needs and objectives change. It WILL change as things like prices and taxes change. And finally, it should NEVER be used as a means of pointing out perceived poor choices in spending by other family members. Therefore, a good budget should always include a Miscellaneous or Other category to accommodate occasional overspending that occurs, unexpected needs and so forth.
In my opening article I also promised to provide an unusual family exercise that allows you to involve children in the financial discussion. While many years have passed, I’ll never forget the impact this had on my son and daughter who were 5 and 10 respectively. So, here it goes!
Consider taking your check(s) for one payroll period and converting it to cash. Have ample dollar bills, fives, ten and twenties. Also have plenty change. Bring your children to the dining room and lay all the money out on the table, along with all of the bills. Tell them what the two stacks represent – – income (what we earn by our work) and expenses and debt payments (what we have to spend to live). Then one by one, take each bill and read it out loud explaining what it is for while you collect an appropriate amount of money from the income stack and put both in an envelope. When this is done there is usually a much smaller amount of money left over on the table. Then take a few more envelopes and give them names like food, clothing purchases, gasoline, etc. and start divvying up the remaining money. Explain that if the money runs out in one envelope we either do without or take money from another envelope. I think you can see where this is going. It’s a GREAT way to show our kids how it really money really works – – that it is earned, spent, saved and so forth, and that the decisions we make in how we use it have repercussions, good or bad. Now I used real cash, knowing that for my kids it would seem more real and important to them, but monopoly money and fake coins can work well too. Try it! I think you may be very surprised at the result.
Well, this brings us to the ‘end of the beginning’ and I hope you’ve found a few tidbits of information or insight that are useful for you in your own financial journey. Next time we’ll discuss what I’ve found to be the single biggest obstacle most face between where they are financially and where they’d like to be.
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