Happy day to you. This is Ken Kaufman and I am thrilled you’re here for episode number 36, “Cash Flow and Net Worth Statements.” We are now going to get on track with getting into detail how to actually build a financial plan, and we are going to take the next several episodes to do it. Back in episode 33 I gave an outline all of the key elements required to build a comprehensive financial plan and today I’m going to give you the first step in building that plan and then the following episodes will follow in sequence of each of those steps required to build out that plan. The first step is a very simple concept. It merely is getting a baseline of what your current financial situation is or what your current financial state of the union is, so to speak. This is so critical to the planning process because you need to know where you’re at so that you can then build the plan from where you’re at moving forward.
Now, just a quick experience. I recently helped a couple pull all of the information needed to organize and display their baseline financial state because they were wanting to do some financial planning and they’d asked some questions and so I was just coaching them on what types of things they needed to pull together to get this baseline pulled together. At first, they were actually reluctant. They felt embarrassed for what they might find or for things that they knew that would show up or appear when stating their current financial situation. Basically, they had these negative emotions towards steering reality in the face and maybe having somebody else look at it too. What’s interesting is is all of the negative emotions were quickly replaced as they gained clarity on their current financial situation or in other words, the more it came together and they looked at it, the more quickly they got past any fear of what somebody might think and the more quickly they started to gain clarity on what was happening with them, and then very quickly they started to think about, now what can we do to improve our situation? What are the next steps? Every human being that I’ve ever met has a choice to either use clarity to feel bad or use clarity to get motivated and start moving forward and start making progress. It’s so hard to make progress though if you don’t know where you are, so you have to stare this in the face and you have to be willing to accept clarity and once you get positive about it, it actually can be a little bit addictive, and you will continue to seek clarity and that’s not a bad thing. It’s actually a very good thing. Clarity puts the stake in the sand so to speak, on your starting point and it’s empowering so that you can build the plan for everything moving forward. And sure, none of us like to dwell on past mistakes from the past that might be exposed in getting this baseline or showing where we’re starting from. But knowing where you stand today, when you combine it with all of the knowledge that you’ve gained through your years of experience and maybe adding in a little…sprinkling in a little bit of good advice or direction how to start moving forward is extremely empowering to this process.
Now, this couple that I helped, they kept saying over and over and I’m going to paraphrase this, “This is so helpful to see this. I had no idea. Now that I can see the whole picture, it is so clear to us what are the best things that we need to start doing now that can most effectively and most quickly improve our financial situation.” And so, it is with anyone that takes on this first step of building a financial plan. Now, the first step requires two major, I’ll call them reports or measurements of your current financial state. The first one is a net worth statement and the second one is a cash flow statement. I’ll start with building net worth. This is something that I talked about back in episode nine. It was titled Track Your Net Worth. I’ll make sure there’s a link in the show notes if you want to easily click through and review that episode or if you haven’t heard that one yet. So there’s some good detail there and I’m not going to cover that portion. What I do want to do is encourage you to just follow the instructions from that episode and then now I want to just talk through what are some of the key things that are going to be revelations that are so critical on this net worth statement. Again, remember net worth statement is, for those of you in business, it’s just a balance sheet. It’s your assets minus your liabilities equals your net worth or your equity. And in business, these net worth statements or balance sheets in terms of seeing the value of a business, it’s really hard to see the value because the value is in a business is how can the assets and liabilities be combined to drive the highest level of earnings for the business. And often, the earnings are far, far greater and higher than anything that shows up on a balance sheet, much different in personal finance where the assets that you’re building and the debts that you’re reducing are dollar for dollar benefit to your overall assets and those assets ability to earn income in the future. Anyways, we’ll get into all that later. So, here’s some of the significant areas of clarity that will come out and jump off the page when you complete this net worth statement.
First is you’re going to get clarity on all of your debts. How much do you owe on each one? What are the terms of each loan or debt, including interest, the length of the loan, the monthly payment, and a full amortization schedule? More on that full amortization schedule and the debt and credit planning section that’s going to come later in the series once we start building the financial plan. But this baseline you’re creating gives all the information needed to build out the debt and credit planning component of your overall comprehensive plan. Now, let’s talk about the assets that are going to show up. How much do you have in the bank and where are you banking? Are you earning interest from that? This all starts to inform the planning process about do you have enough cash cushion for emergencies? Do you have enough cash set aside for any other what we’d call short term needs? The next question it answers is how much do you have in retirement accounts and how many 401(k) accounts do you have and IRAs and 403(b)s, 457s, Roth IRAs, SEP-IRA, solo 401(k)s, I could keep going. There’s so many different options it seems like. But it’s really getting a look at what are all of those and then of the funds that are in them, how are those currently being invested? That lays the framework for the investment planning portion that we’ll get to down the road. Also, how much money do you have in taxable investment accounts? That’s an important thing to know. Also, how much of your net worth is tied up in private interest in business and in businesses that you’re dependent on getting your income from? That’s super important to understand in terms of diversification that will be spelled out in a financial plan. What do your real estate assets look like? How much of those real estate assets are personal residence versus other assets that you are renting or using for other purposes? What about cars, boats, toys, and etc? Mostly referred to as depreciating assets. And then what about any other assets that you have? So, all of this info comes together and paints the picture of your current balance sheet or net worth. This is part one of the two parts needed to establish this financial baseline so that we can launch ourselves confidently and with the clarity we need into the planning process.
The second is a statement of cash flow. And this is simply where you build a representation of your inflows and outflows and the clarity comes in, at least the forms I’m going to mention below and more. Sources of income, including active and passive. This is going to show are what the level of concentration in different income sources is, different types of income. And there’s a big difference between active and passive income and how to ensure on some of those things. Anyways, all that gets into and gives the clarity we need to jump into the planning side. Also then looking at what are all of your outflows, how much is going to debt service, and how much is needed to stay current with your debt payments? How much of your income or of your outflow is for your base living expenses and how much would then be discretionary expenses or just overall discretionary income that you have left and available to do other things with? How much are you contributing to charity? How much are you saving each month, and how much of that is going into a retirement account versus a taxable account or toward other investments or building other assets? And then one final, really important thing is to understand how much are you paying in taxes and what is your effective tax rate in your marginal tax rate?
So, with the net worth and the cash flow statements complete, you will have the foundation in place to jump into the next step in the financial planning process, which is where you start listing your priorities and goals as best as you can, focusing on short, medium, and long term for your family. And please, don’t get discouraged pulling all these statements and data and putting all of this together so that you can get these two financial reports or statements on your current financial state or your current financial baseline. I want to encourage you to push through. It’s worth the effort to pull all of the information to get all of this put together. You are going to love the feeling and the emotions that come from clarity and you’re going to love even more the confidence you gain once you can get into the financial planning process and start to really see out into the future and get really clear direction. So, next week’s episode is going to jump into this concept of listing out your priorities and goals. I promise to give you a very healthy list there of prompts to help you think about as much in the future as you want to take on or you want to think about. Hopefully, it will be a fun exercise. I’m looking forward to it. So, stay tuned. I’m committed to a new episode every Monday morning. Many, many thanks to you for joining today. This is a wrap for episode 36. Happy day.
Episode 33 – Key Elements of a Financial Plan
Episode 9 – Track Your Net Worth