A Company is known by the business that it does but very often we judge it by the financial performance that it demonstrates. The 3 most important financial perspectives for a company are it’s Balance sheet, P & L account and Cash flow statement. I think most people will agree that it will be nice for us to be able to manage our own finances like those of a company. In this post I will try to show you a way in which you can do it quite easily.
First things first – what do the 3 financial documents really mean for a company? Well, you can find extensive information on the internet and several books have great explanations, but let me try and explain it like a layman.
- A Balance sheet is really a record of all the Assets and Liabilities that the company has at any point of time. However, it is typically generated at the end of a financial year. Obviously, it is a good idea if your assets are more than your liabilities, though for businesses just starting up or going through a rough patch this may not be the case.
- A Profit & Loss statement is for a period, usually annual. It records all revenues and expenses that the company has had in that period. Typically, you would expect revenues to be greater than expenses though that may not always be the case.
- A cash flow statement records all cash inflows and outflows in a given period of time. Cash inflows are normally from the sales the business generates while the outflows are for the variety of expenses that the company incurs.
Let us now try to look at how these definitions can be related to the personal finance of any individual or family. I will relate this to my situation so that it will be easier for everyone to understand the linkage.
- Assets for me will be anything that I own which has a monetary value. In other words, if I can sell any of my possessions and convert it to money then it will be an asset. So, by this definition, a home is an asset. A car, the furniture I own, my financial instruments like Stocks and MF units are all assets.
- Liabilities for me will be anything that I owe to people. So, if I have a housing loan from a bank that is a liability. My credit card outstanding amounts are a liability till I pay them and so are all my other unpaid bills.
- My Net worth is the difference between my overall assets and liabilities. As I go through life my net worth would normally increase and would probably be the maximum when I retire.
- My Sales revenues are from any source of Active income that I have. Earlier this used to be from the salary that I received at my work, today it is from the invoices that I raise to my Clients for my Consultancy practice. My Other income revenues are really all the sources of my Passive income, such as dividends, interest, rent etc. My expenses are all the expenses that I incur monthly or annually.
- From a healthy P & L perspective, my total revenues must exceed my total expenses. As long as this happens I will have some money to invest and this will have a positive impact on my net worth. In case this is not so, I am really depleting my assets which is essentially a bad idea.
- My cash inflows are there when my Active and Passive incomes get realized. So when a Consultancy invoice gets paid or when I receive interest from my Tax-free bonds it is cash inflow to me. When I pay my rent, my children’s college fees etc it is cash outflow to me.
- My ability to invest in a month or quarter will depend on whether I have surplus cash available. In other words if my inflows exceed my outflows, I will be able to invest.
I will next do a few posts on strategies you can adopt to run your finances like a company does.
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