In my last post, The Foundation of Personal Finance, I outlined the 6 steps I recommend following in order to set a good foundation in your personal finances.  I’m going to break down each step in a series of posts.  Let’s start with Step 1: Know What’s Going On.
 

Step 1a: Create a Net worth Statement

1. 1. 1. What do you own?  Assets
      2. What do you owe?  Liabilities

 

First we need to develop a net worth statement; a net worth statement is a lot like a balance sheet for a business.  It contains all of the relevant assets and liabilities that have a financial value.  These are assets that are either financial in nature, like a bank account or RRSP, or things that could be turned into money, like a home, business, or investment property. 

 

This statement should not include items needed for your day to day life, like your jewelry, appliances, furniture, or vehicles.  The only exception is when those items are of a significant collectible value.

 

For most households, this does not need to be complicated or terribly precise (to the nearest $1,000 should be adequate) and should contain the following items:

1. Real Estate including your personal residence
2. Bank accounts
3. Investment accounts such as your RRSP, TFSA or RESP
4. Business(es)

 

The net worth statement should also include a list of all of your debts, including:

1. Mortgage
2. Credit cards
3. Loans
4. Lines of credit

 

When you add up all of the assets and subtract all of the liabilities you will have a number that reflects your personal net worth.  This is a number that you should revisit and update annually at a minimum.  Knowing and tracking your net worth and its components will help you plan for the future and develop ways to grow.

 

Here’s an example:

Assets (What do you own?)	Liabilities (What do you owe?)
Home - $800,000	Mortgage - $143,000
Business - $800,000	Visa - $1,500
RRSPs - $390,000	MasterCard - $500
RESP - $80,000
Bank accounts - $25,000
Total Assets: $2,095,000	Total Liabilities: $145,000
Net Worth: $1,950,000

 

 

Step 1b: Create an Income Statement

1. 1. 3. What comes in? Income
      4. What goes out? Expenses

 

After developing your net worth statement, you should work on building an income statement, that is, a statement of all of the money that gets deposited to your account and all of the money that is spent out of your account.  This is NOT a budget, this is a statement of actual cash flows. In other words, a true documented account of what you’ve earned and spent over a particular period of time. 

 

In the past, people balanced a cheque book or used a spreadsheet or ledger system to track income and expenses.  This was a potentially labour intensive and time consuming process, not to mention boring!  Today, technology can be a powerful tool to help with gathering and sorting this information, especially if most of your transactions are not cash. 

 

When it comes to tracking your personal finances there are numerous online solutions to make the experience easier. I personally use RBC’s MyFinanceTracker to sort and track my transactions: http://www.rbcroyalbank.com/mft/available/.  This took a bit of time to set up initially, but now it requires very little monitoring or intervention and it gives our family an accurate picture of our total income and expenses. MyFinanceTracker organized our income and expenses into major categories like mortgage, automobile, charity, insurance, etc. 

 

This is an invaluable tool to provide real time insight into your spending patterns and can show you opportunities for change if you want.

 

During Step 1 it is important to just gather the facts to find out where you are right now.  This knowledge will help you make choices based on facts rather than guesswork.  Maintaining an accurate picture of your net worth and cash flow is vital as we move forward with planning your financial future.