You must know where you are before you can get where you’re going. That’s the power of a Net Worth & Cash Flow Statement.
Imagine a Boeing 747 pilot not knowing where the plane is mid-flight. What if they took off for a four-hour flight, kicked their shoes up, and checked their location four hours later to ensure they arrived? That’s not how flying a plane or piloting a plan works. If you make a financial plan to retire in ten years, the tenth year cannot be the first time you check if you’re on course. If it is, you surely won’t be.
We need to regularly check-in to see our progress and if we are progressing. Primary items we should check: Net Worth & Cash Flow.
Net Worth Statement
Do you know everything you have and what it’s worth? That’s what a Net Worth Statement summarizes.
Remember, there is no correlation between Net Worth and Human Worth. We are all equal. Net Worth is merely a financial measure. Here are the components:
Assets: What you Own
The left side of the statement is the important side. It’s everything you own. This includes:
Debts: What you Owe
Did you use other people’s money to get some of your assets or purchase items and experiences? Then you owe that money. Common debts are:
Using Net Worth
Listing all your assets on the left side (so that they are first) and all your debts on the right on a statement will show you at a glance where everything is and what it’s worth. Typically Net Worth is centered on the bottom.
Now you know where you are. You know what you have and what it’s worth. So what do you do with that?
You may find some planning opportunities when you see it all laid out. Perhaps you have more debt than you thought. Or more cash. Or not enough!
It’s easy to get off course if we aren’t paying attention to our location. Net Worth tells us our current location.
The true power of using a Net Worth Statement is in updating it over time. This allows you to see not just where you are, but where you’ve been. You can see your assets going up and your debt (hopefully) going down. Or maybe neither of those is happening, and that should be a red flag!
Your assets may not go up every year. Maybe, like in 2022, your retirement account values have temporarily declined. It doesn’t always feel good to have a lower Net Worth than last year. But that’s the power of looking at your total net worth and not just investment statements.
While the values of the best businesses in the world went down, perhaps you still:
- Contributed to retirement accounts,
- Paid down debts, and
- Made improvements to increase the value of your home.
You have no control over the economy, but you can control your cash flow and behaviors. It’s deeply empowering to see these positive effects over time, and you can mitigate the impact of a down economy.
And when equity values come back, boy is it fun to see the change in Net Worth then. Viewing these changes and general trends over time is a great way to ensure that you are making progress toward your destination.
Your Net Worth Statement, updated Annually, becomes a GPS beacon that tells you your location on the journey. But if an NWS only tells us where we are and where we’ve been, how do we predict where we will be? Enter the:
Cash Flow Statement
If a Net Worth Statement is a snapshot in time, a Cash Flow Statement is what happened during a timeframe. You may have an NWS for December 31st, 2022, and a Cash Flow Statement for the Calendar Year 2022.
Cash flow has two components:
First, if you’re still working, you’ll have Earned Income. You may also have Interest or Dividend Income. Maybe you have a side hustle for additional Self-Employment Income. Or perhaps you have some Passive Income from rental activity or other sources. If you’re retired, you may have Retirement Distributions, Social Security Income, and perhaps Pension Income. There are many sources of income, and many people are surprised when they see their total gross income from all sources.
The first expense is the only thing besides death that is guaranteed: Taxes. Taxes are the largest expense many people pay, which is why tax planning is so critical. We covered that in episodes 28 and 51 and in our Workshop on Reducing Taxes in Retirement.
Next, you have Debt Payments. You borrowed the money, they want it back. Mortgage, Auto Loans, Student Loans perhaps, credit cards. Etc. You likely also have many Insurance Policies and owe premiums on those.
There is one more category, and then everything else is discretionary spending.
Unless you’re retired, you’re probably saving money. Into your 401(k), Roth IRA, HSA, or even simply a savings account. For some people, this is the last category. They save what’s left after they are done spending. Others save first and spend what’s left. We’ll get into that in a future episode.
How to Use a Cash Flow Statement
A Cash Flow Statement can show you what happened in a year and predict what will happen next year as well. As with a Net Worth Statement, you can learn some things by looking back.
Net Worth not increasing? Perhaps because you’re not saving enough. Not saving enough? Perhaps because your housing payment takes up 30% of your take-home pay, or debt payments represent 50%. It’s hard to focus on the future when you’re still paying for the past.
Paying too much in taxes? Perhaps you need tax planning. There sure is a lot going out to insurance. Perhaps we don’t need the Cadillac health plan or that whole life insurance.
Looking at how much money you made in a year and all the places it goes can teach you a lot about how you’ve gotten to where you are. You may find many things you want to adjust, or maybe just one significant item. Either way, how would you know if you don’t have a Cash Flow Statement? Knowledge acted upon is power. Knowing your finances is deeply empowering.
Looking at your Cash Flow Statements over time can teach you deep and powerful trends whether working or retired.
If you’re working, is your income growing faster than inflation? If so, great! You’re growing and becoming more valuable to society. If not, either you’re not growing, or maybe you need a different job. Either way, Income trends can help you make big life decisions.
Is your Savings Rate increasing? Is the amount of money you save for future spending sufficient, or on track to be sufficient? Or have you been saving 3% of your total income into retirement for three decades with no increase at all? One of the greatest predictors of financial security, independence, and wealth is your savings rate. Not investment rate of return, not interest rate. Savings rate. How much are you saving? And is that rate increasing?
How much is going to debt? How much is paying for the past?
Is your income growing faster than inflation? It’s the same question! If not, maybe it’s time to get a better retirement income plan, like 3D Retirement Income. The first Dimension is Direction: Income that Grows Faster than the Cost of Living. If your income is growing faster than inflation, great! Ensure it also has the Duration to last longer than you and yours. (Ensure it’s 3D income.)
You’re probably not saving if you’re retired. Your question here is the opposite. What is your distribution rate? How much of your total retirement savings are you withdrawing each year? Are your distributions sustainable? How would you know if you don’t know?
The trends you can learn are powerful and lead to better decisions and better outcomes.
How do we make these powerful Net Worth and Cash Flow Statements? That’s the topic of next week. See you then.
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This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are those of the people expressing them. Any performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be directly invested in.