Just as it is important to get a medical check-up from time to time, it is equally important to measure your financial health from time to time.
To take stock of the financial decisions you have made over time and measure the state of your finances. Measuring your financial health helps you to assess and evaluate the quality and impact of the financial decisions you have been taking and to help you re-strategize and plan to improving the state of your finances.
Organizations do this by looking at their financial statements – Balance Sheet and Income Statement. You too need to do the same – analyze your Personal Balance Sheet and your Personal Income Statement, and here is how:
#1: Calculate Your Net-worth:
Your net-worth is the difference between what you OWN (Assets) and what you OWE (Liabilities). To calculate your net-worth, you can list your assets and the corresponding Naira value, as well as your liabilities and their corresponding values.
In determining your assets for the purpose of personal financial planning, you should NOT include depreciating assets (assets that decrease in value over time) – clothes, cars, electronics, furniture, etc. Your assets should be limited to things that can increase in value or whose value is relatively stable – Land, Shares, Cash, Gold, etc.
#2: Your Personal Income Statement:
In addition to calculating your net-worth in your Personal Balance Sheet, you should also be able to create a personal income statement and calculate the surplus or deficit of your monthly income and your expenses.
Your income includes ALL the amounts that you receive from your work, businesses and investments while your expenses include all payments that you make for your household, education, clothing, and even purchases of personal assets.
Finally, reflect on the following measures of financial health that you can get from both statements:
- Your savings rate – how much do you put aside each month towards saving and investing. Prudent people pay themselves first by putting aside about 10-15% of their income each month into savings. Your savings rate is calculated as monthly commitment to savings divided by total monthly income. People who are unable to save consistently each month are unable to store up enough wealth to cater to emergencies and future projects that they have.
- Your cash reserves – how many months of your living expenses can your current level of savings and short-term investments cover. To calculate this, divide the total of your bank accounts and money market investments by your monthly expenses. You should have 3-6 months cover to be generally safe. A lower number means that if you suddenly lose your job and are unable to find new employment or income immediately, you will not have enough to take care of your everyday needs.
- Your Debt to Income Ratio – this is the proportion of your debt: the total amount you owe (mortgage, car loan, outstanding bills and rent, etc.) and your annual income. It is calculated by dividing your Total Debt by your Total Annual Income. The higher this amount is the more dangerous because it means that you will be struggling to pay your debts and still have enough to live on. A debt to income ratio of between 35 and 40% is considered generally safe. Anything higher than that is considered – living dangerously.
Assessing your financial situation helps you identify the things you are doing well, the areas that require improvement, and gives you an indication of the things you need to do to improve your finances.