Whether you are planning a business or desire to leave a significant legacy for your loved ones, you need to know how to handle finances. Planning where your money goes, often called a budget or cash flow plan, is an essential part of financial success. Our goal is to help you understand how a budget works in both business and personal finances and provide education and tools to make managing finances easier
Managing Finances
Whether business or personal, managing finances is actually pretty straightforward, although confusing terms, strange reports and – ugh – math, tend to make most people avoid it like the plague.
For now I’ll stick with the basics.
Income & Expense
Income, or what you earn, is essentially your starting budget. You can only spend what you have. In most cases the formula for an operating budget or cash flow plan is:
Income – Expense = 0
Yes, 0 (zero). The idea is called zero based budgeting, where every dollar of income is accounted for and assigned to a task.
If it helps you can think of the formula more like this, where tasks other than true expenses are more obvious:
Income – Saving – Giving – Expenses = 0
In this case you see that part of how you get to 0 includes things like saving and giving. If you want to see a neat trick on how to save money and become wealthy, do some – I know, ugh – math and determine how much you have for expenses (bills, mortgages, cc payments, food, clothing, utilities, etc.), also called a modified budget:
Income – Saving – Giving = Expenses
I emphasize taking Saving and Giving amounts off the top, because if they aren’t chances are there’s nothing left for either.
Ever wondered what they call this in Business? A Profit and Loss Statement.
Income – Expense = Profit or (Loss)
Even in business, where making a profit is the goal, a true budget would simply show all known profit recorded as retained earnings or being distributed to members or shareholders.
Networth/Equity
I sometimes consider Income and Expense to be the trees of finance, whereas Networth or Equity are the forest.
When you are bogged down in the details, you can lose touch with the big picture. That’s what we are talking about here.
In personal finance we tend to talk about networth as adding up all our assets (bank balances, value of personal and real property, investments and retirement accounts, health savings account, pension, annuities, etc.) and then subtracting all our debts (credit card balances, mortgage balances, school, auto and other loans payable, etc).
Assets – Debts = Networth
This is helpful because it reminds us how our saving and paying off debt is increasing our networth.
In business we essentially do the same thing, but using different terminology because, well, why make things easy?
For one, Assets in business are generally cash balances – liquid assets. Debts in business are called Liabilities. When you take Assets and subtract Liabilities (like we did with assets and debts above) you get what is called Equity.
Assets – Liabilities = Equity
But of course, business finance has to do things differently and so they report it as:
Assets = Liabilities + Equity
This is the basic structure of a Business Balance Sheet report. This format is more for accountants than business owners. As a business owner you want your total Equity to be a positive number (if you have total liabilities that outpace your assets – cash on hand – you will have negative equity or negative networth)
These are the basics – more will be available soon in the form of blog posts