A net worth statement tells you, what, is your financial situation at a given point in time.
Net Worth = Assets – Liabilities
There are 5 types of Assets, which are
Equity which includes Equity Stocks, Equity MFs and ULIPs
Debt which includes FDs, Debt funds, PFs ,Post office investments, Traditional life insurance policy premiums (money back or endowment, etc).
Liquid which includes Cash, Savings account and Current account balance and Liquid Mutual Funds.
Gold which includes Coins, Bars, Gold Funds, Gold ETFs
Real Estate which includes house, land and commercial space
Liabilities would include all your loans.
We have excluded cars and jewellery out of the assets as we may think they are our assets but we seldom sell these. We have included the house you live in assets as we have taken home loan in liabilities. We hardly sell this asset as well.
Now as we talk today net worth can be positive for someone or even negative. A negative figure hints that we should make plan to eventually move towards the positive and build our assets so that our financial goals are achieved.
You need below 2 statements to understand
your current financial situation:
Cash flow statement
Net worth statement
1. Cash Flow Statement
Cash flow statement tells
whether you are generating surplus income post taxes and life style expenses.
This data should be taken for a financial year, as some expenses would be
yearly.
Some professionals and
business owners might at times have no clue if their expenses are exceeding
their income, as their income is variable and people might fail in keeping track
of all the inflows and outflows.
Now putting together a
cash flow statement would tell you how much of investible surplus you have. And
below simple formulas…which have been found to be useful, most of the time….
Could be used to finds the problem areas and take corrective steps.
And even if there are no
problem areas, below ratios should be checked if our surplus is enough for us
to reach our financial goals.
Savings/Take home pay= min
30% (saving for your long term goals such as kids higher education, retirement,
etc.)
(Debt+All household
expenses)/Take home pay=max 50% (households expenses would be ones like food,
entertainment, education, fuel, rent)
Floating expenses=20%(Short
term goals like vacation, car, electronics, etc. and emergency fund for medical
expenses, etc.)
In Next Blog, we will talk about Net Worth Statement.
Importance of financial planning and the steps involved.
Financial planning is the process of utilizing your
available financial resources in the best possible manner so that you achieve
your goals.
Why do you need to have a financial plan?
1.Inflation
Impact: When your mother goes
grocery shopping and comes back, I am sure you must have heard her saying. I
bought rice today at Rs 50 per kg , I used by the same rice at Rs 10 per kg when
you kids were younger. This is inflation. Steady increase in the prices of
goods and services. As the prices of these goods and services increase so does
the cost of our future goals. If today it costs 25 lacs for higher education
abroad, it would cost 73.4 lacs when your kid grows up after16 yrs, if
inflation is at 7%. Inflation has a compounding effect.
2.Contingency
fund availability: You may never know when the job scenario turns gloomy.
Also the yearly hikes are not in line with the prevailing inflation. And so
planning becomes of utmost importance.
With
elderly parents in house and unexpected medical instances on the rise, it calls
for keeping contingency fund ready for such situations. When people don’t plan
for future goals and have surplus income, second home is the preferred choice
of investment which is a very illiquid asset….financial planning helps you take
into account not just your long term goals but even your short term needs.
A thumb rule suggests keeping 6 months’
salary in highly liquid form for this need.
3.Retirement:
Like our father’s generation, we will not be supported by any pension structure
and so planning for the retire life is a crucial aspect. With life expectancy
on the rise, it becomes all the more important to plan your retirement
You would need a retirement corpus of 5.2
cr, if your monthly expenses are @ 50 K today, if you wish to retire at 55 and may
live till age of 80 yrs.
4.Insurances:
Financial planning helps you know your worth, which in turn helps you asses
your insurance needs which shield you family from financial loss in case of
life loss or any medical condition.
This gives you a sense of security as you
are adequately covered.
5.Investments
are tied to goals: Since any money decision impacts your financial planning,
you keep your money decisions in line with the financial plan like decisions on
tax planning, insurances, etc. This also keeps you away from ad hoc
investments. Also you do your tax planning in advance in line with your goals.
6.Cash flow
management: Financial planninghelps
you manage your inflows and outflows in a way that you utilize your resources
in the best way to achieve your goals. Helps you cut out unnecessary expenses
and gives a strong hold over your financial situation.
7.Achieving
your financial goals: You achieve your goals comfortably as you start early
and have a solid plan to meet your goals.
Now that you know why financial planning is essential, below
are the steps which would help you put a financial goals together:
