The Four Categories of Personal Finance
The four categories of personal finance are income, expenses, assets, liabilities
Income is the money you earn from your job, interest on investments, profit from sales. Credit cards and loans are not income.
Most people only have income from their jobs. Are you one of the people who believe that an increase in income will solve all of your problems? Don’t put all your effort into earning more money. Consider the other categories also, as they may produce more benefit. Read my article Is Money Management Your Problem for a discussion of this issue.
Expenses are the money you regularly spend on accommodation, transportation, credit cards, mortgage, loans, etc. Do your expenses exceed your income?
Assets are something with value, that can create income, or increase in value over time, such as a GIC, real estate, or a business. Investing in assets can eventually help with your cash flow.
Liabilities are the money owed. Wealthy people borrow to purchase assets, other people borrow to finance a life style. Examples – credit cards, loans, mortgages.
Note: loans, credit cards, mortgages, etc. are not an additional source of income! They must be repaid, usually with steep interest charges.
Where do you stand?
Get your calculator and work it out. How much do you own minus how much you owe is called your Net Worth. When you were born, your Net Worth was Zero, the same as most everyone else on the planet. Over time, some people add to their Net Worth, others remain static, while a third group subtracts from theirs. Which group are you? If you are in the second or third groups, it’s time to sharpen your pencil and find a way to change that.
If you received a windfall from a lottery win, back pay, inheritance, etc., what would you do with it? Buy something you have always wanted, or use it for a down payment on a new vehicle? Would you use it to pay down a debt such as your mortgage? Would you use it to acquire an Asset? The first two will increase your Liabilities, while the last two will increase your Net Worth. See my article The Best Way to Spend Your Windfall.
A teacher listed ten arithmetic facts on the board. All of the children noticed immediately that one of them was wrong. Why does that matter? Because that is how we view our lives and our finances. Even if 90% of our life is great, we focus on the 10% that isn’t. A baseball player who struck out only 10% of the time, would be the greatest batter of all times, so why do you view a 10% failure rate as a disaster?
Most decisions are of the type, “Do I drink my juice or eat my cereal first?” It doesn’t matter, because at the end of the meal you will have consumed both.
On the other hand, should I put on my shoes or my socks first, does really matter.
When I was young, there were no real winter boots. We used uninsulated, zip up rubber boots called galoshes. To keep our feet warm, we put socks on both before and after we put on our shoes. We tucked the extra socks in our galoshes while we were in class. My point? Sometimes circumstances can change the obvious answer.
What Can You Control
If you are living paycheck to paycheck, and the debts are piling up, you need to consider what you can control and change. The vast majority of people are employees, and as such have little to no control over their income. The only area somewhat within their control is in the expenditure (expenses) column.
Before you can control something, you first must be able to measure it. Before you can measure it, you need to know exactly what it is you are measuring. In this case, you need to know what you spend your money on, before you can decide what, if anything, to do about it.
The only accurate way to know where you spend your money is to track your expenditures. It’s important that you list every expenditure when you make it! Don’t forget to include any interest you pay on loans or credit cards.
You can use a free or inexpensive app on your phone, tablet, computer, or like I do, a little notebook that fits in my shirt pocket (ladies will want to make sure it fits in their everyday purse). I buy the ones with the spiral at the top of the pages from Staples or the Dollar Store for about a dollar.
Write down the date, and everything you spend money on, and whether you use cash, debit, credit card, cheque or electronic payment. Be sure to include the date, what you spent and what you got. Once you have a full month of expenditures, you can put them into categories and enter them into a spreadsheet. You can total each category by hand, but that is tedious work. Check out my free Weekly Habit Tracker on the sidebar, or at Free Weekly Habit Tracker
From the list above, you can prepare a budget. Don’t forget to include expenses that may not occur every month such as taxes, insurance, seasonal gifts, etc. Check out my article Four Tips for Creating a Solid Budget.
The U.S. government provides a helpful budget tool on their site at: Make Budget Worksheet. It is a very simple to use pdf fill in the blanks form.
I have a free budget planner using a spreadsheet rather than a pdf, if you would prefer to do it that way. For your free spreadsheet, go to: Free Budget Planner.