Understanding budgeting and balance sheet basics can help you plan for big purchases…and be prepared for the unexpected.
Imagine this: a once in a lifetime opportunity presents itself to you. Perhaps it is a new home, or a dream vacation, or a business venture. You want to take advantage of this opportunity because you know it won’t be available again. But then reality sets in and you ask yourself: “Do I have enough money?” Without knowing for sure, you may have to wave that once in a lifetime opportunity goodbye.
To help answer this question, it is critical to understand the basics of budgeting and balance sheets. While you may have enough money for your day-to-day expenses, it’s the outliers—positive or negative—that lead to the need to look deeper.
Budgeting Basics
First, you need to determine how much income you receive versus how much you pay out in expenses. By tracking your total income and expenses, you can create your budget to quickly determine if you have money to spend or save, or if you are living beyond your means. This can easily be done in Excel, Google Sheets, or by working with your financial advisor. Budgeting helps you organize your finances and importantly, helps you be prepared for any financial emergencies.
Spotlight on Spending
Having a budget can help you determine if you have any unnecessary expenses. It can also help you control your spending so you can focus on the things that matter most to you. For many of us, we may want to buy that $5 latte every day as we head to work, but by having a budget, we know that if we skip this expense, there will be $100 more at the end of the month for that special item for which we have been saving.
Saving for the Unexpected
Your furnace breaks down during a cold snap; your car needs repairs; you cannot work due to an illness or injury. Everyone has had unexpected events and expenses that require readily available funds, and having a budget helps you know how much money is available for these expenses. Importantly, you can plan for these unexpected costs by saving money in an emergency fund. Your emergency fund should contain three to six months of expenses and should be liquid and easily accessible.
A great way to start building your emergency fund is to automate the savings process. By automating a transfer to your emergency fund account, at each pay period for example, you are treating your emergency fund as another bill to pay. Automation also reduces the possibility that the funds are used for other expenses and makes saving easy.
Extra Credit: Creating a Balance Sheet
While having a budget is the first step in knowing if you have enough money, the second step is having a household balance sheet. A balance sheet provides an overview of what you own and what you owe at a specific point in time. Setting up a balance sheet can be done easily through applications or by working with your financial advisor.
There are three components to a balance sheet: assets, liabilities, and net worth.
Assets are what you own. They include cash, investments, and large assets such as your house or car. These items are further broken down into categories based on how quickly they can be turned to cash to be used to pay debts. For example, cash is a liquid asset that can easily be used to pay a debt, but a house is an illiquid asset that would take some time to convert to cash. If you needed the funds from the sale of your house quickly, you may have to sell at a price lower than what it is worth to get the funds in a timely manner. When creating your balance sheet, assets should be entered at their current market values, and if current market values cannot be found, they should be included using a proxy of a similar item that was sold recently, which you typically can find by performing a simple Internet search.
Liabilities are the money you owe. These include outstanding bills, loans, or credit card balances. Liabilities can also be assigned to categories based on the length of time until the debt is due. Current liabilities are short-term debts that need to be paid within the next year while long term liabilities are those debts, such as a mortgage, that have longer repayment periods.
Net worth is the difference between assets and liabilities. If you have more assets than liabilities, you have a positive net worth. More liabilities than assets, however, means a negative net worth—you owe more than you own. Negative net worth is not an ideal situation. But you can improve your net worth by increasing your assets, reducing your liabilities, or some combination of the two.
Informed Spending
By using a balance sheet in conjunction with a budget, you can focus on generating extra cash each month to either reduce your debt or increase your assets. Once you’re on a clearer path, you’ll be able to make a sound decision on whether you can afford that once in a lifetime opportunity. Knowing how much money you can spend along with what assets and liabilities you have is an important first step toward understanding your financial situation and meeting your financial goals.
If you would like to learn more about the basics of budgeting and setting up a balance sheet, please reach out to us at contactus@sbhic.com or call us at (800) 836-4265. If you are nearing retirement, we would welcome the opportunity to provide you with a retirement-readiness assessment.
Last updated April 2021. This information has been prepared solely for informational purposes and is not intended to provide or should not be relied upon for accounting, legal, tax, or investment advice. The factual statements herein have been taken from sources we believe to be reliable, but such statements are made without any representation as to accuracy or completeness. These materials are subject to change, completion, or amendment from time to time without notice, and Segall Bryant & Hamill is not under any obligation to keep you advised of such changes. This document and its contents are proprietary to Segall Bryant & Hamill, and no part of this document or its subject matter should be reproduced, disseminated, or disclosed without the written consent of Segall Bryant & Hamill. Any unauthorized use is prohibited.