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When we are trying to understand Personal Finance, the best thing to do is to understand what Personal Finance is NOT.
Many people think that accounting and personal finance are the same, but Personal Finance is NOT Accounting.
On
the surface they may seem the same; they both have something to do with
money. However, the definitions will help us better understand the
differences.
Merriam-Webster's definition of accounting is "the
system of recording and summarizing business and financial transactions
and analyzing, verifying, and reporting the results."
Based on
this definition, we see that accounting is the process of analysing and
recording what you have already done with your money.
This is why having an accountant is usually not enough when it comes to your personal finances.
Accountants
generally don't concern themselves with personal finance (there are
some exceptions to this rule). Unless your accountant is also a
financial advisor or coach, he or she will likely just look at what you
have done with your money at the end of the year and provide you with a
report of their analysis.
This report is usually your tax return; what you owe the government or what the government owes you.
Very
rarely does the accountant provide an individual with a Balance Sheet
or Income Statement or a Net worth statement; all very helpful tools
that are necessary to effectively manage your personal finances.
Personal
Finance is looking at your finances from a more pro-active and goal
oriented perspective. This is what provides the accountants with
something to record, verify and analyze.
The Merriam-Webster's
(Concise Encyclopedia) definition of "Finance" is the "process of
raising funds or capital for any kind of expenditure. Consumers,
business firms, and governments often do not have the funds they need to
make purchases or conduct their operations, while savers and investors
have funds that could earn interest or dividends if put to productive
use. Finance is the process of channeling funds from savers to users in
the form of credit, loans, or invested capital through agencies
including COMMERCIAL BANKS, SAVINGS AND LOAN ASSOCIATIONS, and such
nonbank organizations as CREDIT UNIONS and investment companies. Finance
can be divided into three broad areas: BUSINESS FINANCE, PERSONAL
FINANCE, and public finance. All three involve generating budgets and
managing funds for the optimum results".
Personal Finance Simplified
By understanding the definition of "finance" we can break our "personal finance" down into 3 simple activities:-
1. The process of raising funds or capital for any kind of expenditure = Generating an Income.
A Business gets money through the sale of their products and services. This is labeled "revenue" or "income". Some businesses will also invest a portion of their revenue to generate more income (interest income).
A Business gets money through the sale of their products and services. This is labeled "revenue" or "income". Some businesses will also invest a portion of their revenue to generate more income (interest income).
A Person gets money through a job, or a small business
(self employment, sole proprietorship, network marketing or other small
business venture). The money coming in can be a salary, hourly wage, or
commission, and is also referred to as income.
A Government gets
money through taxes that we pay. This is one of the main ways that the
government generates an income that is then used to build infrastructure
like roads, bridges, schools, hospitals etc for our cities.
2. Using our money to make purchases = Spending Money.
How much we spend relative to how much we make is what makes the difference between having optimum results in our personal finances. Making good spending decisions is critical to achieving financial wealth - regardless of how much you make.
How much we spend relative to how much we make is what makes the difference between having optimum results in our personal finances. Making good spending decisions is critical to achieving financial wealth - regardless of how much you make.
3. Getting optimum results = Keeping as much of our money as possible
It's not how much you MAKE that matters - its how much you KEEP that really matters when it comes to your personal finances.
It's not how much you MAKE that matters - its how much you KEEP that really matters when it comes to your personal finances.
This is the part of personal finance that virtually everyone finds the most challenging.
Often
people who make large incomes (six figures or more) also tend to spend
just as much (or more) which means they put themselves in debt and that
debt starts to accrue interest. Before long that debt can start to grow
exponentially and can destroy any hope they would have had to achieving
wealth.
Personal Finance made simple
Personal Finance doesn't need to be complicated if you keep this simple formula in mind:
INCOME - SPENDING = WHAT YOU KEEP
For
Optimal Results you simply have to make more than what you spend and
spend less than what you make so you can keep more for you and your
family!
If you are not actively working towards an optimal result you will by default get less than optimal results
It really is that simple!
Now that you understand personal finance and WHAT you need to do, the next step is learning HOW to do this!
The best way to start is by following these 3 simple steps:-
1.
Know what you want to achieve - "if you don't know where you are going,
any road will take you there" has become a very popular quote, probably
because it is so true. One of the habits that Stephen Covey highlights
in his book "7 Habits of Highly Successful People", is to always start
with the end in mind. Knowing where you want to go will be a big help in
ensuring you get there.
2. Have a plan - that you can follow that
will get you to your goals. Knowing how you will achieve your goals in a
step by step plan is invaluable. Sometimes this is easier with the help
of an advisor or a financial coach.
3. Use tools and resources -
that will help you to stick to your plan and not become distracted by
the things in life that could limit our incomes and make us spend more
than we should. Don't try and work it all out in your head! You will end
up with a massive headache and your finances will become one gigantic
dark fog!
