Is your financial health important to you? If your answer is no, stop here! I learned a long time ago that I cannot influence everyone so I focus on the people who realize that my information is important to them. An annual checkup involves a physical examination, laboratory tests, vital signs and monitor any changes in health. An examination of your financial health is an opportunity to monitor your progress.
Medical Checkup
A medical physical involves determining your physical health and a financial checkup is an examination of your financial health. Similar to a medical checkup, it involves an examination, questions and answers and financial ratios to assess your financial health.
If I were your financial doctor, I would look at your last year’s budget performance, five year plan, net worth at the beginning and end of 2014 and financial ratios. The ratios can be used to analyze trends or measure progress.
Financial Checkup
Most people do not analyze their financial statements, calculate their net worth or check any ratios. Is it necessary? The results are important and you do not have to go through everything to achieve the results. When I was a Chief Financial Officer (CFO), I routinely performed or reviewed financial statements, budgets and financial ratios to determine the financial health of the companies I worked for or owned. It became second nature and I will try to provide a simple approach for your financial health.
Ratios
- Savings to income – Savings includes all forms of savings including stocks, bonds, mutual funds, retirement accounts etc. Gross income includes income earned business, profession or in the form of salary, bonus, commission, interest, dividends and any other form of income. Savings/income is based on the annual amount contributed or earned. The ideal savings rate is at least 10%.
- Debt to income – Bankers often look at this ratio when it comes to lending you money. A low number (below 36) indicates you have a good balance between debt and income. In order to calculate your debt to income ratio, take your monthly debt payments and divide it by your monthly gross income.
- Savings rate to income – This ratio is important to know if you are on track to saving enough for retirement. Since most people do not save enough for retirement, this ratio is important. Too often, people put off saving in their twenties thinking it will be easier in their thirties or they think it is so far off, it doesn’t matter. Your savings rate should start early and increase your savings as your income increases. The ideal savings rate is 10% of your after tax income.
- Personal net worth ratio – You r net worth is a good way to measure your financial progress from year to year. It is important to calculate your net worth as of the last day of the year. It is the total of all your assets (real and personal property including cash and investments) minus your liabilities (debt, and other financial obligations). For example, you may include the value of your home as an asset and your mortgage as a liability.
Last year’s budget performance and 5 year plan
When you set up your budget you had a particular financial goal in mind, how you performed is important. Maybe you wanted to save 10 % or pay off debt over a five (5) year period or 30% a year. Your performance will affect next year’s budget and ultimately your five (5) year plan. It does not stop there because it will impact your long range goals too. If you were successful in meeting or achieving your goals, you may want to increase your goals. If you failed, you want to analyze your performance!
Budget analysis
Good or bad performance should always be analyzed to find why you succeeded or failed. If you failed, it may be discretionary spending such as dining out or it could be an emergency you did not foresee. Either way, you should take the appropriate action to remedy it for the next budget. If your rent/mortgage is too high, you need to take action. You may consider selling or renting a room. Analysis is not criticism; instead it is a wakeup call for action. What are you going to do?
Long range planning
Annual budgets are necessary to help you reach or achieve your financial goals, but it should be part of longer range planning. After all most goals, particularly financial goals take longer than twelve (12) months! When I started investing, my goal was financial independence. As I achieved financial independence, I changed my goal to sustainability. I needed/wanted to make sure that I could sustain my lifestyle for an extended period of time. Multiple income streams became my long range goal!
Long range planning is taking lifetime goals such as career, financial, family, investing, etc. and creating smaller or short term goals or milestones in order to achieve them over your lifetime. Every year, you check your progress using a variety of measurements. If you are not making sufficient progress toward your goals, you make changes. The hard part is determining the length of time to achieve your goals. There are risks and uncertainties that are difficult to forecast or quantify.
Final thoughts
Checking your financial health should be important to you because it affects your future plans. Taking an objective look at your financial ratios and progress toward your goals is similar to an annual physical examination. I analyze my financial health annually to evaluate my asset allocation regarding my investments. I also periodically review my investments to evaluate m y investment choices if I add any money. First and foremost, I believe in planning because I am responsible for my financial health.
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It’s important to do this. I liken it to financial reports that companies need to do. You want to know how you’re doing with respect to income/expenses, as well as assets/liabilities. Further, it’s a good idea to assess risks as well.
It is exactly like a company! These ratios are time tested and really provide a lot of information. Everyone should use these annually if not more often.
It takes looking at real numbers to improve and actually stick to a budget and meet financial goals. Once I started taking the time to input my actual in and outflows, I got super motivated to increase my savings each year.
The annual checkup is a reality check. You review where you are and how you are doing. It is also a good time to create an action plan.
Planning and checking your financial health is very important for all of us. It’s really needed to do this annually. It’s really helpful and useful. Thanks for sharing it.
You’re welcome! Reviewing your progress based on sound numbers is important for business and individuals.