Today I wanted to share something based on more than 2000 answers to my Financial IQ test. It seems that many people struggle with budgeting and keeping their Personal Financial Statement. I have put together three best practices that might help you organize your thoughts on keeping your financial records. Enjoy reading.
Personal Financial Statement best practice #1 – what is your time horizon?
Number one best practice when it comes to a personal financial statement that I have found extremely beneficial is using at least an annual time horizon. Let me explain why.
You need to take a year as your budget period to factor in expenses and revenues that happen less frequently than monthly, for example, real estate taxes, car service, various memberships, etc. Without taking a year’s view on the budget, you may think in certain months of the year that you can save. It may turn out though, that you are not saving at all. You may also find out that you keep spending more than you earn.
The top 1% of people who have the highest Financial IQ use a year as their planning time horizon. You can read more about more personal finance habits of top 1% here. Financial Independence lessons learned. Financial Independence Lessons Learned
Personal Financial Statement best practice #2 – what are your key metrics?
The second Personal Financial Statement best practice I use is to focus on the key metrics. Based on over 2000 responses to my financial IQ test the top 1% people agree that the three key metrics that you need to monitor and improve over time are: debt to income ratio, fixed expenses to income ratio and investments to income ratio. Let me explain why.
- debt to income ratio – financial independence does not necessarily mean that you are debt free. One of the reasons is that there are different types of debt. Some debt may drag you down other can significantly accelerate your journey to financial independence. Irrespective of the type of debt you carry you need to always understand how much in percent your annual debt payments are in relation to your net income. You will probably not want to see this metric greater than 25%.
- fixed expenses to income ratio – another metric that is closely observed by those who achieved financial independence is how much they must spend on fixed expenses in relation to their net income annually. When we include debt payments discussed above you will probably not want to see this metric to be more than 35%.
- investments to income ratio – finally the most important metric that is a consequence of the two previous ones. How much you invest annually compared to your net income. Do you choose an easy road and let other people manage it or you make your own decisions and build financial independence on your own. How much of your investments give you additional cash flow?
Personal Financial Statement best practice #3 – what are your strategy and corresponding actions?
My third Personal Financial Statement best practice I that I use current year numbers, analyze them and plan how I can improve my key metrics next year. I always focus on two categories at the same time to get the best results.
First of all, I put my attention to expense planning.
I have this habit to review my fixed expenses every year and look for ways to reduce them. When have you last reviewed your contracts with utility suppliers to see if you can renegotiate a better price or cancel some of the options that you currently have and do not use? How often do you review your contracts with utility suppliers? These are just sample questions you should be asking yourself. Here is a quick win for you!
- Firstly, make a list of all your recurring payments
- Then, note down when you have signed/ amended the contract
- Step three, note down what is the annual charge
- Finally, make a phone call, renegotiate, cancel or change
- Make sure you execute those four baby steps within one week. You will immediately start seeing more cash in your bank account.
Another habit that I have is to brainstorm revenue opportunities every single year.
Let me tell you how this works.
- Step one – think about your annual revenue target and write down ten opportunities that you have in your mind to achieve it. There is the world of opportunities out there. Think about freelancing or review some ways to make income online. Have a look at what you already own and if you can turn it into a source of passive income.
- Step two – organize the list of opportunities. Look at the ones that are most probable to be achieved within one year. As soon as you understand your chances, look at those few top ones that have the greatest revenue potential.
- Step three – plan victory around actions, not the target itself. Now that you have your top opportunities selected think about what actions you need to take today, following week, next month and this quarter to progress. Write down those actions.
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