A core aspect of controlling your finances is living within your means. Basically, don't spend more than you earn. Easier said than done but it helps if you have a budget. Let's dive back to a concept you probably learned in school but never cared enough to remember.
What is a Budget?
A budget will allow you to see how much you earn after taxes and how much money goes towards your living expenses. You can create your own budget by carefully tracking your regular expenses with a pen and paper, use Microsoft Excel's template or you can choose to find an online template from the internet. When your income is greater than your expenses, you have a surplus. This means you have leftover money to use after your spending. Alternatively, if your income is less than your expenses, you have a deficit. This means you don't have enough money to pay for all of your expenses.
Income > Expenses SURPLUS
Income < Expenses DEFICIT
For surpluses, here are some financially responsible ways to use the extra funds:
- Save the funds towards an emergency savings account
- Decrease your debt by making lump-sum payments
- Invest the funds
For deficits, you would need to consider adjusting your budget to make it into a surplus. You cannot run on a deficit for long as this means you may be acquiring more debt to fund your current lifestyle. Here are some things to consider:
- Increase your income - either with another job or another source of income
- Decrease your expenses - cut back, switch to a lower cost or eliminate an expense
- Change your lifestyle
It's important to watch your spending and avoid running a deficit whenever possible. If you are on a deficit, you are likely to run a balance on overdraft protection, credit cards, line of credits or loans. All of these products accumulate interest, which is additional money that you have to pay. I understand that it's important to also enjoy life but excessively spending on wants over needs will negatively affect your financial and personal life. It's important to consider allocating some money for enjoyment as well because no one lives to only pay their bills. That would be a very sad life.
What is Net Worth?
You hear about it all the time on the news, radio or some form of online entertainment outlet. The net worth of Bill Gates is $90 billion. The net worth of Jeff Bezos is $140 billion. This is simply a measure of their wealth. Does this mean they have billions of dollars in a savings account? Most likely not. If you remember my savings account post, the interest rate for the big banks in Canada is currently less than 1%. It would be financially smarter to find a higher return elsewhere.
Net worth can be broken down into 2 parts:
- Assets
- Liabilities
Liabilities are things you OWE which decreases your value. These include debts, loans and future expected payments from you.
Your total net worth is calculated when you consider both of these aspects together. To find your net worth, you can use this formula or use this net worth calculator.
Net Worth = Assets – Liabilities
It's important to keep a positive net worth because it means you have less debt compared to the value of the things you own. When considering an application for a future mortgage and other credit loans, your application is also more likely to be accepted if you had a positive net worth. Having a negative net worth isn't necessarily always bad as you can consider having loans a temporary setback. This can be considered an investment to expand your business, upgrade your skills or increase your future income. As long as it's responsible, a temporary negative net worth can be healthy.
Budgeting plays an important role in increasing your net worth by efficiently managing your money to decrease your liabilities and increase your assets. The ideal scenario is to aim for zero liabilities and to further grow your net worth as high as you can.
Be sure to start budgeting if you haven't already done so!
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