Apart from doing personal financial consulting I also do business consulting. During the past few weeks I have been working with a company who wish to get better insight into the financial position of their company. I am not an accountant and their accountants wanted bookkeeping answers while I was contracted to help give them financial management insight. Even though the two appear to be the same thing, they are not. The leading question to distinguish the difference is when asked what is the most important financial instrument. They replied that it was the income statement. The answer is in fact the budget. The income statement reflects and records the facts as they occurred in the past whereas a budget indicates how monetary spending must occur in future. The first thus looks backward and records history while the budget looks forward and guides us toward where we want to be.
After I realised that individuals and businesses make the same mistakes I decided that this week we need to find out how to make sense of overcoming the same financial errors in business and personal finances, when we:
- Do not know our budget
- Do not plan
- Do not make savings a priority
In business we need to make sales for a profit and to make a profit we must sell something, producing a cost of the sale. In much the same way we will personally earn an income but will have to spend time and money to go to work making use of transport and related cost. This is what we sell to gain the income. The amount we are left with; the difference between income and expenses to produce the income is generally referred to as gross profit. With this money we will be able to pay all other expenses, or standing charges: rent (bonds), telephone, wages, electricity, education, provisions (food), cleaning supplies, car, fuel, entertainment and more.
If we are going to record these costs afterward we are reactive and recording the history, often finding that we have too little left to properly pay the other expenses. We must rather budget. We will often find out when we budget that the distance we need to travel will be so expensive that there will not be enough left to pay all the other expenses. The income statement (record of expenses) will show this after the fact and we will have already incurred the costs; and, then it could be too late. In that instance we have to then cut the budget on other items to be able to continue to pay the necessary transport costs to produce the income.
We notice that the budget is a planning tool and will overcome the second common mistake of not planning. When we can apportion each expense and have something left we know that the plan is working and when the budget reveals that there is nothing left or a shortfall arises we must know that the plan will not work. Only a budget, where we plan and plot the expenses, will show whether a plan is successful. We must plan and we must use the budget to design the plan.
The third mistake has the direst of consequences and this one will determine whether we can retire, travel and enjoy the better things in life – saving. The net profit is the savings in a business and will empower it to grow as much as savings will make the individual grow. A business will do their budget planning and must always ensure that there is a net profit. The problem with the lay-out of the income statement is that the net profit appears at the bottom of the sheet when all other expenses have been paid. This problem causes business owners to not give the proper priority to net profit and even if it appears at the bottom of the page it should be at the top of priorities.
We treat savings in much the same way and allow the amount remaining at the end to be assigned to savings. This alone will make us realise why less that 1% of people save when they allow their expenses to overcome their savings. In our personal budgets (and in business) we have the opportunity to create a line item for savings, thus becoming like an expense. By doing this we are giving savings a higher priority and when we make it the first item on our budget we are giving it the best position of highest priority. This is where savings should be, right at the top of your expenses register.