In the last article you made a list of all of your needs and desires. You then picked the one thing you really want and focused on it. As you recall, Bob picked pilot lessons as the one thing most important to him. You might have picked a down payment on your first home, or a really nice new car, or a college education for your daughter. The problem for Bob, and perhaps for you as well, is that the chosen thing requires a rather sizable amount of money. For example, Bob's pilot lessons cost about $4,000. Bob's question: "Where in the world am I going to get that kind of money??? I have not saved a dime in the last two years and I have a $2,000 credit card balance. There is no way I am going to be able to collect $4,000 any time in the next decade."
This question - "Where in the world am I going to get that kind of money???" - is the central question for anyone who wants to gain control of their finances. It is the one question that can trigger the transformation from random money management to controlled money management. The reason you made a list of all of your desires and then picked the one thing you really want is simple: If you really want that one thing, you may be willing to put in some extra effort, and perhaps endure a little pain, to get it.
For Bob (and for you) the first step down the path of control involves a discovery process. Bob earns plenty of money, but it all dissappears. Bob needs to figure out what happens to all of his money on a monthly basis. There are many ways that you can do this, but probably the easiest is to put a piece of paper in your wallet or check book and try, for a period of one month, to track every cent that you spend during that period of time. The reason that you want to do this is because you will probably be amazed at how you spend money right now. You must go through this step if you are to gain control of your finances and get the things that you really want.
There are several conclusions that you can draw from Bob's expense listing:
The next thing to do is to divide all of the money you spend up by category to try to organize it a little. Bob's categorization looks like this:
Rent 700.00
Car payment 300.00
Gas, oil change, etc. 70.47
Power bill 76.47
Phone bill 37.16
Groceries 134.19
Cell phone 42.76
Cable TV 49.17
Computer 122.81
Music 25.66
Entertainment, lunches, etc. 421.94
-------
1980.63
Note that the total number here is lower than the grand total from the expense listing. The $275 Visa payment from the expense listing was eliminated, on the assumption that it paid for the previous month's expenses and would therefore be redundant to include here (to be technically correct, however, you might want to include the interest charge from the Visa bill among the expenses that you list in your categorization).
To complete your categorization, you really have to think a little bit more deeply than this. A one-month expense listing is likely to either over-estimate or under-estimate your actual monthly expenses because some expenses do not occur every month. For example, Bob has to pay a $487.42 car insurance payment ever 6 months. He also pays $85 in renter's insurance each year. He has the following gift occasions each year: mother's day, father's day, Mother's birthday, father's birthday, sister's birthday, Christmas. The total gift giving each year is about $350.00. There was a $112 property tax bill last November that came at a bad time. The car will need new tires every three years and tires cost about $360.00. And so on. Try to determine all of "hidden" expenses like this, make a list, and divide by 12. For Bob the annual hidden expense total is a little over $1,100 so the average monthly expense is $96.21. His true monthly expenditure is therefore $2,076.84, or $226.84 greater than income.
 | You can use the hidden expense calculator to help you calculate all of your own hidden expenses and to determine how much you should be setting aside each month to cover them. (To run this calculator you will need a web browser that understands JavaScript. The later versions of NetScape, the MS Internet Explorer, etc. all do) |
If you took the time to do this exercise, and really recorded all of your expenses over 30 days, and considered your longer-term expenses as well, and came up with a total expense number and compared it with your income, then what you have just completed is a true cash flow analysis. You know how cash flows in and out of your household. It may be that you found this analysis depressing. You may find that your situation is very much like Bob's. Your monthly expenses may be just a bit higher than income, leading to a slowly growing credit card bill. You may also have a big problem every six months when the car insurance bill comes due. Or maybe not. Maybe you are a bit more prudent than Bob and actually have a little money left over at the end of each month. Either way, it is important to know your true position.
| You can use the Monthly Cash Flow Calculator to help you calculate all of your own monthly income and expenses and determine your cash flow. (To run this calculator you will need a web browser that understands JavaScript. The later versions of NetScape, the MS Internet Explorer, etc. all do) |
The other half of understanding your household finances is to create what is called a balance sheet (also known as a net worth statement). A balance sheet shows where you stand in terms of your assets and liabilities. The assets are what you own, while the liabilities are what you owe. Here is Bob's balance sheet.
Balance Sheet for Bob
Assets
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Savings account $230
US Savings Bond $500
Furniture $4000
Computer $1000
Camera $600
Car $6000
------
$12330
Liabilities
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Car loan balance $6500
Visa balance $2000
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$8500
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Balance $3830
This balance sheet shows Bob is $3,830 ahead. That is, he has more assets than liabilities at the moment. Note that his car is worth slightly less than the loan amount. That is not good, but if you are in that position there is nothing you can do about it but attempt to avoid it in the future. If you happen to own a house, you may want to leave the house out of it for now to create a simpler view of things. If you are married with three kids, a house, two cars, a boat and a dog, you may find that your expense listing and balance sheet are somewhat more complicated than Bob's. Persevere, because knowing where you are at is important to gaining control.
| You can use the Net Worth calculator to help you calculate your own net worth. (To run this calculator you will need a web browser that understands JavaScript. The later versions of NetScape, the MS Internet Explorer, etc. all do) |
You now have a good view of where you are. You may not like it,
but at least you have it. In the next article we will explore
how you can use this information to reach your one true desire.
