Question

How do financial statements / budget tools contribute to your personal financial management?

Answer 1

The core of personal financial management is financial decision making. Financial management forms the basis for financial planning, analysis and decision making. Financial information is contained in financial statements and is required to aid in financial decision making. Financial management provides a framework for financial decision making which involves the following:

1. Financial Planning: - It involves the process of assessing the financial situation, determining financial objectives and formulating a plan to achieve them. It is the process of meeting life's goals through proper management of one's finances.
2. Financial Statements: - These are collection of data organized in accordance with logical and consistent accounting procedure. They reflect an individual’s performance over a period of time and the financial position at a point of time. The analysis of financial statement is a process of evaluating the relationship between components of statement to obtain a better understanding of financial position.

· Balance Sheet is a quantitative summary of one’s financial condition at a specific point in time which includes assets, liabilities and net worth. It is a snapshot of the financial health.

· Income Expense statement provides information of the income earned and the costs and expenses incurred to earn such incomes during a given period. It is a score board of an individual performance during a period of time.

· Fund Flow Statements reflect the change in cash or change in working capital. Working capital is the difference between current assets and current liabilities. They determine the liquidity position of an individual. It describes the sources from which additional funds are derived and the uses to which these funds are put. Thus, Fund Flow analysis consists of two distinctively different analyses namely.

· The output of working capital analysis is fund flow statement which is an important indicator of financial analysis and control. It is valuable aid in evaluating the future flow of fund on the basis of past data and to assess the growth. It is useful in planning intermediate and long-term financing.

· The output of cash flow analysis is cash flow statement that provides the information about cash flows associated with operating, investing and financial activities of an individual during an accounting period. It is useful in cash planning.

3. Financial analysis: - It is a process of selection, relation and evaluation of financial data. It is a mathematical classification of data. It includes

· Transforming financial data into a relational form that can be analysed

· Evaluating the financial data for achievement of financial goals

4. Budgeting: - It is a structured process and planning activity, dealing with a family’s financial resources and context. Budget is a pro-active, focused, technical and disciplined strategy to handle the current financial situation of a family. It is a barometer of family’s fiscal condition, resources and health. A budget is a comprehensive and coordinated plan expressed in financial terms for operations (reflected in revenue and expenses) of an individual for some specified period in the future. As a tool of financial planning, budget serves as a guide to the conduct of operations and a basis for evaluating actual results.

Personal financial management process uses a step wise process that helps to determine where the person stands financially. The process involves gathering financial information, setting life goals, examining the current financial status and coming up with a strategy/plan for meeting the goals given the current situation and future plans. It is an on-going process.

Thus, budget tools help in setting up goals and financial statements shows the current situation and helps in overcoming any short comes from the set goals.

Budget tools helps in planning stage whereas financial statements of the person come at the controlling stage, wherein we compare the actual result with the set goal. We can see the steps in Personal financial management process in brief below:

1. SET GOALS: Setting financial goals is the most important indicator of ones being financially evolved. Knowing what is important to an individual and his family is a critical first step in a successful personal financial plan. Any major decision of life like buying a house/car, travel, retirement or higher studies that needs money for its fruition is a financial goal.

A well-defined financial goal is SMART

o Specific - what you want to achieve.

o Measurable - how much money you will need.

o Achievable – which can be achievable

o Reasonable – whether it can be achieved with the time and money available.

o Tied to a time frame - when you want to achieve the goal.

2. DETERMINE INCOME/EXPENSE (BUDGETING): Keep track of actual expenses incurred during the month and group them into various categories like housing, utilities, insurance, social, recreation, entertainment, and “other". Understand and categorize expenses in fixed, flexible, and periodic expenses.
3. TRACKING ASSETS AND LIABILITIES: In the next step, Assets and liabilities are ascertained. Assets are valuable economic recourses owned by an individual which adds on to economic worth. They can be classified as: current assets and fixed assets. Liabilities refer to total amount of debts and obligations that an individual has to pay or fulfil in future. They can be classified as: current liabilities and fixed liabilities.
4. RECORD FINANCIAL TRANSACTIONS: In addition to track the cash you spend, record every bill payment; debit/credit card expenditures which include the amount paid, and the date on which purchase is made. Don’t forget to record all cheque details also. Writing expenditures down provides the unique opportunity to visualize and find out where money goes. Moreover, a written financial plan is far more effective than a mental one.
5. AUTOMATE THE PROCESS: The next step is to look at the present situation by preparing the net worth statement (also referred to as a Balance Sheet) using a spread sheet program, online service, or other personal finance program.
6. EVALUATE: The last step in a successful financial plan is to periodically evaluate and revise plan. Compare planned spending and saving to the amount actually spent and saved. This step will allow measuring the progress toward financial goals. At the end, if a person is not satisfied with the performance, it’s time to make some slight revisions to his plan. In fact, plan should change as the need changes and as a person progresses towards his goal.