Having a healthy personal finance is one of the major pillars in leading a happy life.
Imagine a version of yourself in the parallel universe, living a 9-to-5 life, struggling to make ends meet every month. One day after work, when you take a glimpse on your bank account, there is only less than a hundred dollars left, and there is still a week to go before the next payday.......Would you be able to have sweet dreams during the nights?
And there's another version of yourself, still living a 9-to-5 life, however you only work for interest but not the money. Every month, a stash of cash appears on your table, the amount is good enough to cover all your living expenses.
Which version would you prefer to become your reality?
The answer is straightforward. However, the first leap of faith is the hardest, you just have to do it.
Finance is made up of numbers. You have to get yourself in love of numbers before you can excel in the Financial Freedom Game. It is because, understanding a few basic numbers can give you a good picture of your financial health and help you plan your future. You may not find these jargons unfamiliar as they are always being mentioned in personal finance articles and in the news. So here they are:
1) Net worth
Net worth is the most important measure of one's overall financial situation. This is how much one's worth in monetary terms. We always come across on how much a celebrity or an entrepreneur worth and this is it. The richest person on Earth, Jeff Bezos, as Amazon's founder and CEO, was the first person in modern history to accumulate a fortune of over US$100 billion — and he currently has a net worth of US$130 billion (Bloomberg estimates).
The calculation of net worth is simple: Subtract everything you owe from everything you have:
Net Worth = Total Assets - Total Liabilities
Assets include all property you own (including your home, your car, your boat, your private jet, etc.), cash savings, investments, commodities, and the money in your bank accounts, etc.
Liabilities include credit card debt, personal loan balance, mortgage balance, car loan balance, and other debt such as student loan, investment loan, etc. It's possible to have negative net worth if your liabilities exceed your assets; In fact, this is quite a common situation for those who failed to manage their own finance, eventually leading to bankruptcy.
To increase your net worth, you have to increase your assets, and/or reduce your debt. Do both simultaneously, and you'll be on your way to improving your financial health very quickly.
2) Gross income
Gross income is your total income before any deduction on taxes and withholding. Most salary offers and salary statistics are given in terms of gross income. This is also the number that you report on your income tax returns. Gross income can be confusing for budget planning, since you'll never really pocket the full salary, therefore you don't have this much money to spend.
3) Net income (Disposable Income)
Your net income (some called disposable income) is how much money actually flowing into your account. This may be from your job (active income), from your investments (passive income), royalties (passive income) or any other forms of income, after deducting taxes and withholding. This is an important number because this is how much money you have available to work with to pay for expenses, and to save and invest.
Net Income = Gross Income - Taxes & Withholding
4) Burn Rate (Expenses)
Expenses (burn rate), could be calculated monthly (most common) yearly or even weekly, is one of the most important figures you have to know, and even you should get control over. This is the money you have to spare to pay your bills, including housing, food, clothing, transportation, entertainment, education, etc.
There is always room to reduce the burn rate to leave you with more money available to pay down debt or invest. Control your burn rate, compare it with your net income and make sure there is always a surplus.
5) Saving Rate
The savings rate is the percentage of net income that a person save rather than spend on consumption. Your savings is your net income minus your burn rate.
Savings = Net Income - Burn Rate (Expenses)
Saving Rate = Savings / Net Income x 100
For example, if you have has a net income of $10 left over after taxes and spend $8 in expenditures, then your savings are $2. Dividing savings by net income yields a savings rate of 20% (($2/$10) x 100).
In economic terms, saving is choice to forego some current consumption in favor of increased future consumption (delayed gratification). You simply resists the temptation of an immediate reward in preference for a later reward. In fact, our saving rate affects how much money available for doing investments. Needless to say, the higher the saving rate, the more money you will keep and to invest, which means quicker for you to achieve Financial Freedom.