RPF-0026-Statement_of_Cash_Flows
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00:00:32.000 | Radical Personal Finance, episode 26. Welcome to the show. No fancy music today because
00:00:38.100 | I am podcasting from the road and I don't have the equipment, so we're just going to
00:00:41.360 | get right into it. Today is episode 26 for Wednesday, July 23. And in today's show, we
00:00:48.300 | are going to continue our conversation on financial statements. And before you groan
00:00:55.100 | and say, "Joshua, why do we have to talk about financial statements?" Let me take a moment
00:00:58.820 | and try to sell you on the concept of preparing financial statements. Today, we're going to
00:01:03.500 | focus on the statement of cash flows. And this will be a continuation from episode 22
00:01:10.540 | in which I introduced the statement of financial condition or the balance sheet. And a statement
00:01:14.700 | of cash flows basically says, "Here's where the cash is coming from and here's where it's
00:01:18.140 | going," and we track it. Now, most people when they come to talking about financial statements,
00:01:24.340 | most people are usually thinking more about creating a budget or something along those
00:01:28.860 | lines. But I promise you that building financial statements and proper financial statements,
00:01:34.420 | especially statement of financial condition and also a cash flow statement, this is where
00:01:40.060 | you have to start. So whether you're doing it for yourself and you're coaching yourself
00:01:43.740 | through your financial situation or whether you're doing it for a client, whether you're
00:01:48.700 | a financial planner of some kind, this is where everything starts. Once you become skilled
00:01:53.700 | with understanding how to read financial statements, you will have the skills that you need to be
00:01:59.220 | able to look at any situation and immediately know where somebody is and where somebody
00:02:04.580 | is going. Financial statements that are properly prepared, they don't lie about what you can
00:02:09.420 | expect from the future. So that's what we're going to talk about today. Hope you enjoyed
00:02:13.180 | the interview yesterday with Jacob Lund Fisker. I enjoyed it. I would love some feedback.
00:02:18.380 | I know that was a lengthy show and again, as I said in the intro to that show, that's
00:02:22.380 | the type of thing that I enjoy personally finding, but I don't want to just, you know,
00:02:26.820 | I do want to be sensitive to what other people enjoy. So I'd love to know your feedback of
00:02:30.540 | that show to find out whether it was a format that you enjoyed, more of a conversational
00:02:35.700 | format to get to know someone a little bit deeper. To me, I find that more interesting
00:02:39.820 | than the typical interviewer format where you launch a list of questions at somebody
00:02:44.540 | and just sit back and wait for them, wait for them to answer. So I'd be curious, I'd
00:02:49.900 | be very interested in your feedback. Thank you for those of you who are doing reviews.
00:02:53.540 | I'm traveling at the moment so I don't have those able to pull up and read, but those
00:02:57.660 | are super helpful. We are currently featured in the new and noteworthy section for the
00:03:01.600 | investing section. I would love to be able to get over into the general business category
00:03:06.220 | as well and I couldn't, we wouldn't have been able to achieve that without your positive
00:03:10.500 | reviews and I want to thank each and every one of you for doing that. If you haven't
00:03:13.900 | done so, if you take a moment and just pull out your phone and leave us a review and a
00:03:16.900 | comment, that would be super helpful. It's very easy if you just go to RadicalPersonalFinance.com/iTunes
00:03:23.820 | on your computer or if you're on a mobile device, if you're on an iOS device, pull up
00:03:29.980 | the Radical Personal Finance podcast in the podcast listings and you'll see easily where
00:03:34.980 | you can leave a review and I want to thank you for that.
00:03:38.660 | So financial statements, as I stated, you may want to listen prior to this show, you
00:03:41.900 | may want to listen to show number 22 which was about the statement of financial condition
00:03:47.140 | and this follows from show 19 where I tried to walk through for CFP certificates or students
00:03:53.380 | of CFP curriculum the overall financial planning process as part of the CFP exam. And as I've
00:04:01.500 | said in previous shows, I'm not trying to make everyone into certified financial planners
00:04:07.380 | but I do think the CFP curriculum is a good overview. And I realized when I was recording
00:04:12.100 | show 19 that I probably did too much too fast and so that's why I'm trying to go back and
00:04:18.260 | slow down and record more information on these financial statements. And ultimately, what
00:04:22.740 | I'd love to create out of this is a series of shows that could serve as a curriculum
00:04:26.860 | for somebody who is just getting serious about their finances and wanting to sit down and
00:04:30.460 | say okay where do I start? Because the conversation with Jacob yesterday, hopefully it was very
00:04:36.260 | inspiring but at the end of the day, we didn't really give anybody any action steps. We didn't
00:04:41.740 | really say here's what you can do. We talked about philosophy and we talked about maybe
00:04:46.480 | some philosophies and ideas you've never heard but you don't have anything that you actually
00:04:50.340 | did, you know, I didn't leave you with okay do step one, step two. So I want to create
00:04:55.340 | a curriculum that somebody could follow where if you're inspired or you have financial goals
00:05:00.020 | laid out for yourself that you have the opportunity to sit back and say what kind of curriculum
00:05:05.900 | or what can I now do to change my situation? And it starts with preparing good financial
00:05:12.900 | statements. Now statement of cash flows is basically we're going to track all of the
00:05:16.260 | money that comes into your life and all the money that goes out of your life and this
00:05:20.580 | is going to be basically tracking cash flows. If we were doing business accounting, we would
00:05:24.900 | need to account for things a little bit different because in business accounting, you may have
00:05:31.220 | accruals, you may have revenues, you may have cash, you have lots more accounts. So for
00:05:34.860 | today we're just going to stay simple and focus on cash flows because that's all we
00:05:38.220 | need to worry about as individuals. Preparing a cash flow statement as a financial planner
00:05:44.180 | for a client is very challenging and the reason it's challenging is because most people don't
00:05:48.400 | track their money. So there's almost like an elementary level, then there's a more advanced
00:05:54.000 | level. So the very first thing, if you're not tracking your money in some way, I would
00:05:59.740 | encourage you to track your money. And there are some really easy ways to do this. The
00:06:05.860 | easiest ones that I know of are using some sort of free online software such as the most
00:06:11.380 | popular one is Mint.com. Another popular one right now is Personal Capital. There are several
00:06:17.100 | dozen of these that I have found that various apps, various websites that you can use. The
00:06:22.940 | big, the two big guns that I'm aware of are however, Personal Capital and Mint.com. Your
00:06:28.780 | bank or credit union also likely has some kind of built-in software and you can use
00:06:34.340 | that built-in software to track your expenses. And if you've never tracked your expenses,
00:06:39.580 | I would encourage you to start there. Track your expenses for a month or two and then
00:06:44.540 | use that to try to extrapolate out to build your statement of cash flows. Now you could
00:06:49.060 | also build your statement of cash flows with an estimate, but you really are going to want
00:06:54.260 | to have some actual data to pull from to really understand what your actual situation is.
00:07:01.020 | The biggest challenge, one of the biggest challenges as a financial planner is to try
00:07:06.140 | to help people understand what they actually spend. Very few people that I have ever encountered
00:07:12.660 | actually know what they actually spend. Now I can, when I'm constructing financial statements
00:07:16.860 | and taking a look at their situation, I can usually predict almost exactly what someone
00:07:21.140 | is spending. I take their income, I pull out the tax rates, I can calculate their tax rates
00:07:27.460 | based upon their income, based upon what they're doing, and then I look to see if they have
00:07:30.860 | any savings and to see if they're adding to their savings. And if I don't see any consistent
00:07:35.900 | savings, I just take their income, pull out their savings and that's what they're spending.
00:07:39.220 | And for most people that's fairly simple. Very few people in this country, or at least
00:07:43.820 | few people that have become clients of mine over time, that I can show, okay, here's how
00:07:48.660 | much they're saving every month. Usually the only savings that get accrued over the long
00:07:53.180 | term are savings into things like retirement accounts, pension plans, things like that.
00:07:58.100 | Those are mainly the savings that get accrued. Now some people do still save in a savings
00:08:03.380 | account, but generally people that are saving in a savings account often are earmarking
00:08:07.780 | that just for maybe once a year type of expenses. So you may be setting money aside in a savings
00:08:13.260 | account, but that's viewed as an account for a vacation fund or for a new car fund, things
00:08:18.060 | like that. And that's fine, but that would be an expense. That's not technically going
00:08:22.540 | to be a long term savings, that's going to be an expense. So we want to build a statement
00:08:26.420 | of cash flows. So how do we do it? Well, there's a very simple formula. You have all of the
00:08:33.420 | income or inflows minus all of the outflows or outgo, income outgo, I like to play with
00:08:41.540 | the words, but you have all of the inflows of cash into your life minus all of the outflows,
00:08:46.580 | whether that's fixed outflows, variable outflows, or taxes, and that equals your savings. So
00:08:51.620 | that equals the amount of money that you can save into your accounts. And then that's the
00:08:58.260 | money that you can deploy into other ways. So as far as inflows, the inflows would be
00:09:07.340 | if you were working at a job, the inflows would be your gross income. And so gross income,
00:09:11.980 | if you're not familiar with the accounting terms, gross income and net income, gross
00:09:16.100 | would be the number that is your actual salary prior to any deductions for taxes or prior
00:09:21.740 | to any deductions for benefits of any kind. That would be your gross income. Net income
00:09:27.460 | is the amount of money that you would actually receive in your paycheck after the deductions
00:09:31.660 | for your employment taxes, after the deductions for your income taxes, and after the deductions
00:09:37.500 | for any kind of group benefits that you have established. So we just like to use the word
00:09:42.380 | inflows or gross income. They are equivalent. I don't care which one you use. I like to
00:09:47.260 | use the fancy word because they make me feel cool, make me feel more like a business person,
00:09:52.140 | but you can use whichever one you want. So this would be any salaries that you have.
00:09:56.620 | So any salaries for the household, any investment income. So this would be any capital gains
00:10:02.120 | that you've received, any interest income or dividend income. This would be any rental
00:10:07.140 | income if you have any rental portfolios or real estate that you are managing. Rental
00:10:13.360 | income, if you were divorced, it would be any alimony that you've received or any child
00:10:17.700 | support payments, any social security income if you're receiving any of that, any trust
00:10:23.820 | fund income if you were the beneficiary of a trust, any inheritance income, any gifts
00:10:30.700 | that you received, just any source of income, any winnings, lottery winnings, gambling winnings,
00:10:36.380 | any source of income that you have, that would be listed in the inflows. And we want to make
00:10:40.420 | sure that we have a comprehensive list and we want to make sure that each of these things
00:10:45.260 | is properly itemized. And so we would list out on the cash flow statement. I've created
00:10:50.420 | a sample one in the show notes that you can reference as a Google doc so you can see it's
00:10:54.260 | very simple. You'd want to list out all of the inflows that you receive. So if you have
00:10:58.500 | a two salary earning household, you put one salary, the other salary. If you have one
00:11:04.460 | person owns a business and one person has a job, then you would go ahead and schedule
00:11:08.260 | that out separately so you can reach the number of your total inflows. And total inflows again
00:11:13.540 | should be your gross income prior to any taxes, prior to any deductions whatsoever. This is
00:11:20.740 | the biggest mistake that I see people make is that they're often trying to create these
00:11:28.500 | with net income. And you want to make sure you're using gross income. So if your salary
00:11:32.340 | is $100,000 a year or $50,000 a year, you want to make sure you use that number. And
00:11:36.740 | the reason is that one of the areas that we want to focus on saving is on taxes. Well,
00:11:41.060 | if you're using a net income number, then you're ignoring your taxes. You're ignoring
00:11:46.660 | the employment taxes that you're paying. So if we were going to change some kind of
00:11:49.500 | business entity, let's say you were self-employed and we were going to change you from a sole
00:11:53.020 | proprietorship over to an S corporation with the goal of reducing your self-employment
00:11:57.780 | taxes. Or if you are earning an income, but you're not deferring enough money into a retirement
00:12:03.780 | plan and let's say that we could arrange a plan to defer your income. We want to make
00:12:07.640 | sure that we have that listed so that we can have a separate tax category so we can show
00:12:14.060 | that savings. Good tax planning is probably going to be a very primary way that we can
00:12:21.140 | save a substantial amount of money. So then we're going to go to outflows. So inflows
00:12:25.300 | minus outflows minus taxes equals savings or investments. So we're going to divide our
00:12:31.180 | outflows into fixed outflows and variable outflows. Fixed outflows are those that are
00:12:38.180 | predictable. They're set. We know them in advance. Now, remember that these can all
00:12:43.660 | be changed. So the first thing if we were talking and you had high fixed outflows, you
00:12:50.460 | had a high mortgage payment or a high rent payment, the first thing you said, "I want
00:12:53.700 | to save money," I would say, "Well, can we cut this mortgage payment? Can we cut this
00:12:56.740 | rent payment?" But for the purpose of a statement of cash flows, we're just going to go ahead
00:13:00.180 | and designate it as a fixed outflow. So the fixed outflow would be any debt payments that
00:13:05.100 | you have. Do you have payments on any student loans that are set at a set amount? Do you
00:13:09.380 | have any car payments? This would be any mortgage payments or any rent payments for your housing.
00:13:14.300 | Do you have property taxes on any property that you own? Do you have any insurance premiums
00:13:20.020 | that are set, that are established, that are not going to be changing? Any other fixed
00:13:25.180 | outflows in your budget that are not really going to change from month to month or year
00:13:29.540 | to year. That would all go under your fixed outflow category. Now, if you have any note
00:13:35.700 | payments or debt payments such as a mortgage payment or student loan payments or things
00:13:39.940 | like that under the fixed outflow category, one additional layer that you can go to if
00:13:45.060 | you're interested, and this would be a little bit deeper than I would suggest for just the
00:13:48.680 | average person, but you're probably not the average person if you're listening to this
00:13:52.060 | podcast, is I like to break out what percentage of the payment is going towards principal
00:14:00.380 | of the debt versus what percentage of the payment is going towards interest of the debt.
00:14:04.780 | Because if you have, let's say you have a mortgage payment and you have $1,000 a month
00:14:08.940 | principal and interest mortgage payment and you're very early in the loan, so it's $12,000
00:14:13.660 | a year, let's say that $2,000 a year is going towards principal reduction and $10,000 a
00:14:19.180 | year is going towards interest payments. That's a very different scenario than later in the
00:14:24.620 | loan term where $2,000 is going to interest payments and $10,000 is going to principal.
00:14:29.540 | So I like to break that out and make a note of where you're at in the mortgage amortization
00:14:34.500 | schedule or where you're at in the student loan schedule. This will help you with your
00:14:38.420 | planning because your mortgage interest may be a deductible expense, your student loan
00:14:43.540 | interest may be a deductible expense, so it's good to have that noted there. And it will
00:14:47.420 | also help you to really get a good sense of what's actually going on. Again, if you're
00:14:53.100 | early in a mortgage and you're paying $12,000 a year, all of that's going to interest. Doesn't
00:14:59.340 | mean it's a bad idea, but it means you need to be aware of it so that you can consider
00:15:04.100 | it as you are comparing all of your options. And this is where, back to the constant discussion
00:15:14.100 | that we have of should I buy a house or should I rent a house, this needs to be a major discussion
00:15:18.460 | because many people say, "Well, I'm better off if I buy a house, but I'm only going to
00:15:22.660 | live there for a few years." Well, remember, all of your payments in those first few years,
00:15:26.940 | essentially, almost all of your payments are going to interest. So it's really no more
00:15:30.700 | than a rental expense is you're paying interest payments. Now, are they deductible interest
00:15:35.540 | payments? They might be, versus a rental expense? They might be. But it's a very different scenario
00:15:40.660 | to say, "I'm going to buy a house and I'm going to live there for 30 years," versus
00:15:43.460 | "I'm going to buy a house and I'm going to live there for 3 years." And so you want to
00:15:46.300 | take that into account, what percentage of your mortgage payments are actually going
00:15:51.060 | to principal versus going to interest. And again, I've seen this constantly working with
00:15:55.540 | clients that they say, "Well, look, I bought a house and it's a good deal." Well, you bought
00:16:00.900 | a house for $300,000 and you took out a $250,000 mortgage and you turned around and you sold
00:16:06.800 | the house 4 years later and your principal on the mortgage was $230,000. You'd only had
00:16:12.100 | $20,000 of principal paid down. So when you're actually running your rent versus buy calculation,
00:16:19.460 | you would need to take into account what else could I have done with the $50,000 down payment
00:16:30.980 | that I put on my house and the interest payments. Would I have been better off if I had factored
00:16:37.100 | in that I had to just pay all those interest payments and the taxes and the insurance?
00:16:41.700 | Would I have been better off renting an equivalent property and investing that $50,000 elsewhere?
00:16:47.180 | And very few people ever do that calculation. So I would encourage you to incorporate that
00:16:51.220 | into your life and say, "What would be my actual calculation?" So as with most things
00:16:57.000 | in financial planning, there's not one answer. It's not that one answer is better than another.
00:17:02.340 | It's that you need to look at it. And this is one of the biggest fallacies. Remember,
00:17:05.700 | when you take a mortgage out, all of your money is not building equity. A very small
00:17:10.140 | percentage of your money is building equity in the beginning. And now over the long term,
00:17:14.140 | yes, it will build equity, but it's not in the beginning. So continuing on, the next
00:17:19.580 | category that would be variable outflows. So here you would put anything that you spend
00:17:23.500 | money on that is flexible. So whether this is food, entertainment, clothes, gifts, whether
00:17:30.100 | this is car maintenance, car gas, whether this is home maintenance, utilities, electric
00:17:36.580 | bill, gas bill, water bill, vacations that you go on, charities that you support, any
00:17:42.940 | expenses whatsoever that may change from time to time. You'd want to list these out because
00:17:49.140 | these are going to be the easiest to adjust if you need to adjust something. They're going
00:17:52.420 | to be easier to adjust than the fixed payments. And also you need to know that they're going
00:17:57.100 | to be changing over time so that you can just plan for that so that your statement of cash
00:18:04.660 | flows will reflect that. The third category is taxes. So then you would list out any taxes
00:18:11.220 | that you have. So now this is very important. This is the one that again, that I, this is
00:18:17.700 | my pet peeve is that most people when they do a statement of cash flows, they don't include
00:18:21.860 | taxes. So for taxes, include your actual income taxes. Now you may not know what your actual
00:18:28.100 | income taxes are for the current year. And there's a couple of ways to do this. If last
00:18:32.580 | year was similar to this year, then go ahead and use last year's number. Look up your tax
00:18:38.180 | return. Look at the return to find your total tax paid. The line that shows your total income
00:18:45.180 | tax paid. Let me pause a second, go look that up so I can give you the exact line number.
00:18:50.300 | Okay, I just looked it up. I wasn't sure. I always get my numbers, line numbers mixed
00:18:55.580 | up. You're going to look at your 1040 and you're going to look at line number 61. And
00:19:00.700 | line 61 is your total tax. That's the line that you want to pay attention to. So you
00:19:06.620 | want to include your total tax there as your income taxes. So that would be an important
00:19:12.860 | part. So under taxes, put your income taxes again, estimate using last year if you don't
00:19:17.540 | know. And if you do know what your actual tax would be projected to be for this year,
00:19:24.380 | then go ahead and do that. The other aspect of your taxes that you want to make sure that
00:19:29.140 | you list out here are your employment taxes. So this would be your Medicare and your social
00:19:34.380 | security taxes. This is fairly straightforward and fairly simple. The best way to do this
00:19:39.900 | is because you've started with your gross income is to apply the formula that's going
00:19:44.340 | to be applied to your paycheck. Now your employer is already withholding these numbers, but
00:19:49.860 | you want to go ahead and list them on here so that you're aware of them. This is maybe
00:19:53.540 | a political thing for me, but it annoys me just as a political basis. It annoys me that
00:19:58.740 | people don't realize how much of their paycheck is actually being lost to go for taxes. So
00:20:09.420 | I think you need to be aware of it. Even though you're not going to be able to change it right
00:20:12.780 | now, especially if you're employed, although we could get to other planning ideas for how
00:20:16.140 | you could change it, you want to be aware of it. So the current tax rate for 2014 for
00:20:20.740 | social security is 6.2% for the employer and 6.2% for the employee. So what you do is you
00:20:28.060 | would take your income and you would multiply that times 6.2%. If you're doing this in a
00:20:33.660 | spreadsheet for a formula, remember to convert that to a decimal so it would be .062. So
00:20:40.020 | multiply your gross income times .062. Now this is only applicable for the first $117,000
00:20:49.580 | of earnings. So the way social security taxes work is that there's a wage base and this
00:20:53.300 | wage base is changed every year. But only the first $117,000 of your earnings are taxed
00:21:02.500 | for the purposes of social security. So if your salary is higher than $117,000, then
00:21:08.180 | fill in here for your social security taxes. Just multiply $117,000 times 6.2% and fill
00:21:15.020 | that in. The other aspect of social security tax, of employment taxes, are Medicare taxes.
00:21:21.860 | Medicare taxes are 1.45% for the employer and 1.45% for the employee. So you'll need
00:21:29.400 | to take your total income, and there is no cap on Medicare taxes. So if you have $500,000
00:21:36.660 | of wages, you would need to multiply $500,000 times 1.45%. We'll ignore the Obamacare 3.8%
00:21:46.660 | Medicare tax for the purpose of this conversation. So let's just stay simple and apply the 1.45%
00:21:51.620 | Medicare tax. Multiply that times your wages and list that out as a separate line item.
00:21:59.580 | Just by listing it, you will start to see, that will make you aware of it and it will
00:22:05.300 | make you aware of some of the planning opportunities. So you can see that if social security has
00:22:10.980 | a wage base of $117,000, if you're a high income earner, then it's much less onerous
00:22:17.620 | to you to have wages if you're already exceeding that wage base and you don't need to worry
00:22:21.780 | so much about saving that 6.2%. But if you're right in that middle income scenario, that's
00:22:28.260 | a heavy amount. That's $100,000 income. That's $6,200 a year that is out of your pocket.
00:22:36.540 | And that's another $6,200 a year that's out of your employer's pocket. So I would like
00:22:41.220 | everybody to include these taxes on their base because I think it would help people
00:22:46.060 | to pay attention to how they vote and to pay attention to what that money is being spent
00:22:50.660 | on. If you have a business, you would list out any self-employment taxes that you have
00:22:56.100 | here. So let's say that you are self-employed. Well, the way self-employment taxes work is
00:23:01.260 | you pay the 6.2% for the employer rate plus the 6.2% for the employee rate plus the 1.45%
00:23:08.140 | for the employer rate and then plus the 1.45% for the employee rate. And I think if my math
00:23:14.100 | is right, that comes out to, what is it, 15.3. I think that's right. I'd have to check the
00:23:20.820 | math. I won't bother right now. But if you add all that up, that comes out to your self-employment
00:23:24.460 | taxes. So you'd want to list that here and you want to have that as a separate line item.
00:23:29.580 | So by having each of these as a separate line item, now you have your statement of cash
00:23:33.220 | flows. And now you would look at it and whatever's left over at the end of that, all inflows
00:23:38.540 | minus fixed outflows minus variable outflows equals taxes. And that equals, at the end,
00:23:44.380 | you're left with either a surplus or a deficit. So if you have a surplus, now you have savings
00:23:49.180 | and investments that you can use. And now you have savings and investments that you
00:23:54.580 | can use. Or if you have a deficit, well, you know you've got a problem because you're going
00:23:57.900 | into debt. Now, this may be fine on a short-term basis or it may not be fine on a longer-term
00:24:02.500 | basis. This statement will tell you a lot. And now you can go ahead. And if you have
00:24:08.140 | any kind of fixed investments that you're making, go ahead and construct a separate
00:24:15.140 | savings and investment category. And so a simple one here would be if you were saying,
00:24:21.420 | "Okay, I'm going to add in a 401(k) contribution at my job. Well, let's say we're going to
00:24:26.660 | put in $10,000 of 401(k) contribution." Now, if you have the ability or if you have the
00:24:31.940 | ability to use a piece of software to run the tax tables, now you would notice that
00:24:35.820 | you could go ahead and reduce off the amount of income taxes you're going to be paying
00:24:40.620 | because that amount of income taxes, that money is not going to be taxed for income.
00:24:48.100 | Your FICA taxes are going to stay consistent. So the 401(k) contributions are still going
00:24:53.500 | to have FICA taxes, which is an interesting little tidbit in case you're not aware. It
00:24:57.260 | wasn't originally that way. Originally, when the 401(k) was discovered as an option and
00:25:05.180 | when some of these deferred programs were developed, that by putting money into the
00:25:10.780 | account, you could avoid the employment taxes on the money. But there was such a dramatic
00:25:18.140 | shortfall of money in the first, I don't remember, the first year, couple years, there was such
00:25:23.680 | a dramatic decrease in the government's revenues based upon that people avoiding that tax that
00:25:31.540 | they quickly, Congress quickly passed a new law that reversed that. At the moment, the
00:25:36.180 | only retirement account that I'm aware of under which, off the top of my head, under
00:25:40.180 | which you can avoid completely the taxes would be the HSA account. So if you were going to,
00:25:46.460 | let's say that you were going to contribute to a health savings account and you were going
00:25:49.500 | to put $3,000 in there, then you would put a line item, savings and investments, $3,000,
00:25:55.800 | and that's going to reduce your income taxes, so you would recalculate your income tax rate.
00:26:00.960 | And then that's also going to reduce your employment taxes. So that would save you the
00:26:04.700 | 6.2% on the $3,000 and that would save you the 1.45% on the $3,000. So I don't want to
00:26:11.860 | get bogged down completely in an audio podcast here, but the thing I want to show you is
00:26:18.620 | that all of these are, that this is how you look at it and this is how you look at it
00:26:24.100 | in totality. Because at the end of the day, this financial statement will determine your
00:26:29.460 | financial future. There is nothing, if this financial statement, if you see that we have
00:26:36.300 | low inflows and high outflows, it's not going to be possible to build wealth. If you see
00:26:41.780 | that we have high inflows and low outflows, it's going to be possible to build wealth.
00:26:46.420 | And then we're going to figure out how to do it in the most efficient way possible.
00:26:50.020 | So if I were answering, if I were doing financial consulting for somebody, if I could have just
00:26:57.740 | well constructed, a well constructed statement of cash flows and a well constructed statement
00:27:02.420 | of financial condition that were actually accurate, I could figure out every answer
00:27:08.140 | to every question and I can predict exactly how much their net worth is going to increase
00:27:12.220 | year to year. I can predict the answer to almost every single question just by having
00:27:17.220 | these statements well in hand. So I would encourage you, if you've never done it, to
00:27:23.220 | construct these. Now, a couple of, a little bit of commentary and then we're done for
00:27:26.860 | the day. First of all, it's tough to get accurate numbers. So most clients, if you're
00:27:32.100 | working with clients, most clients do not have accurate numbers. If you're working
00:27:36.380 | for yourself, most of you, most of you listening, probably don't have accurate numbers. So
00:27:42.540 | I would encourage you to start with tracking it. Track all the money in, track all the
00:27:47.100 | money out. How to do it? There's various ways to do it. You can do it a free way. I
00:27:51.780 | personally just simply use a manual spreadsheet, although I am in the process of transitioning
00:27:56.780 | over. I just use a simple Excel spreadsheet, but I'm in the process of moving to a double
00:28:01.300 | entry system for my own personal accounting because I've out, I'm not able to do it with
00:28:08.780 | single entry accounting. There's some stuff, there's some info that I want for my own life
00:28:11.900 | for all you accounting wonks that I'm not getting with a single entry spreadsheet system.
00:28:17.340 | But that's fine for most people. If you just chart it in the spreadsheet and chart out
00:28:23.860 | when you receive income, chart it out to show what the amounts are and break them into categories.
00:28:32.140 | I don't have an easy solution for how to do this unless you're a bit of a nerd. Again,
00:28:36.060 | I do it in Excel, but I don't have an easy solution. This is my beef with a lot of the
00:28:40.620 | cash flow tracking systems that whether it's Mint or things like that is that when you
00:28:45.460 | put a paycheck in, it just says paycheck. And so it doesn't, there's a way to track
00:28:49.860 | the expenses, but there's no way to track the amount that was deducted for taxes or
00:28:55.460 | the amount that was deducted for 401ks and things like that. And that's why my manual
00:29:01.340 | system that I use or some other kind of double entry system or an actual quick book, an actual
00:29:08.100 | accounting software is going to be far more powerful than is just an expense tracker.
00:29:13.180 | However, there's no reason why we can't just simply create these statements manually. So
00:29:18.500 | if I know what someone's expenses are and I know what their income is, then I can go
00:29:22.600 | ahead and create this and can calculate everything manually and that's no problem at all. But
00:29:27.540 | we want to create it and we want to go ahead and calculate it because this will tell us
00:29:31.180 | everything that we need to know. So with these two statements, plus we're going to get to
00:29:34.860 | a, we're going to talk about kind of having a debt schedule and figuring out how, how
00:29:39.460 | we should pay off the order that we should pay off debt. We really can see everything
00:29:44.580 | about our financial life that we need to see. We can see what our income is. We can see
00:29:48.780 | what the outflow is. We can see all of the details of where our money's going. We can
00:29:54.660 | see what, what options we have for the money to grow. We can see what we're investing in.
00:30:01.140 | We can predict net worth. We can predict it all and it's all based upon these numbers.
00:30:05.340 | I think that's all, really all I want to talk about for today. Budgeting. This cash flow
00:30:12.340 | statement is not necessarily from the perspective of budgeting, I guess would be the last thing,
00:30:17.460 | is that you'll generally hear, you'll generally hear people talking about making a budget,
00:30:24.220 | making a budget, making a budget. Making a budget I think is valuable. In business you
00:30:28.660 | would have just a few accounting terms that you may find helpful. In business you would
00:30:34.460 | have a pro forma cash flow statement or a pro forma statement. Pro forma is just a fancy
00:30:39.540 | word that means an estimated, an estimated, what the estimated expected results are of
00:30:47.860 | the next accounting period. This would be similar to what a budget would be. In personal
00:30:53.300 | finance usually people are just viewing a budget as what am I going to spend and what
00:30:56.900 | am I not going to spend. Now the budget is powerful because the budget is the forward
00:31:00.860 | looking thing. A budget is a really powerful thing. I'm not too concerned in this section,
00:31:07.620 | in this statement about the budget because I figure, especially if you're working with
00:31:11.260 | clients, this is not for yourself. The difference is that I can't tell a client what they should
00:31:16.580 | or shouldn't do. I'm just concerned about what they are doing. So the cash flow statement
00:31:21.260 | is designed to tell me here's what they are doing, what they have done. I personally feel
00:31:26.580 | that if you have a good handle on what you are doing and if you have a good handle on
00:31:30.500 | what your goals are and you understand what you're doing and how it's going to impact
00:31:35.140 | and affect going forward, then you'll be able to naturally make the course corrections.
00:31:41.100 | And you may or may not use a budgeting process. And a budgeting process would be great. That
00:31:45.420 | would be simple. It could just create a simple, here's what I would like my cash flow statement
00:31:50.020 | to be step by step going forward. The value of having all these categories is that we
00:31:54.980 | can now address a plan of savings. So now we can look at a cash flow statement and we
00:32:01.500 | can break it down into categories and we can say, "What can I do this month to try to figure
00:32:08.500 | out how to save in this specific category?" Which by the way, I just created a video that
00:32:16.500 | I'd like to plug and I'll put a link in the show notes if you'd like to see a video that
00:32:19.380 | I created for a contest leading up to the FinCon conference that I'll be going to in
00:32:25.140 | September which is a conference of financial bloggers. I'm interested in meeting some of
00:32:29.140 | the other people in the online financial space. But my tip that I created the video on was
00:32:36.140 | each month pick one category of your life and then look to optimize it and figure out
00:32:41.660 | what can I do in this category. Well, if you have an accurate cash flow statement, now
00:32:45.380 | you know your categories. So one month you may be looking at the homeowner's insurance
00:32:49.540 | and you say, "Well, this month I'm going to work on homeowner's insurance. I'm going to
00:32:52.340 | review my coverages. I'm going to call around. I'm going to get different quotes from different
00:32:56.300 | people. I'm going to see what I can do in this category to really improve things." The
00:33:00.940 | next month it may be car gas. You say, "What could I do?" Well, maybe look at me, look
00:33:05.580 | around and see if there's some way I could get a rebate system. If there's some credit
00:33:09.060 | card system I could sign up for that would give me a 5% cash back on gas expenses at
00:33:14.460 | this certain place. Maybe I could learn and understand some hyper-miling techniques. Maybe
00:33:19.260 | I could figure out a better route to work that's going to save me money. Maybe I could
00:33:24.940 | figure out a public transportation route instead of the car, etc., etc., etc. So by having them
00:33:29.860 | listed here you can make a note of them and you can make a note of some of the things
00:33:32.820 | that you can change to do. So hopefully this is helpful. Again, this is Financial Planning
00:33:37.500 | 101. I would love to see every person have constructed for themselves a current cash
00:33:43.180 | flow statement. This is really, especially if you're going to work with a financial planner,
00:33:47.940 | this is step one. Because every change and every optimization that you're going to make,
00:33:52.800 | you need to see it reflected on the cash flow statement to be able to show the difference
00:33:56.940 | and to show how the savings work. If you implement a retirement plan, you want to see the income
00:34:01.500 | taxes go down. If you implement a cost saving measure and you cut insurance, you want to
00:34:07.420 | see the savings go up. If you pay off principal on a debt, you want to see the net worth go
00:34:13.020 | up. So the net worth will go up any time someone makes a mortgage payment. You'll see the net
00:34:17.580 | worth go up by the amount of the principal reduction amount of that payment. So the interplay
00:34:22.380 | between these two statements, the statement of financial condition and the statement of
00:34:25.340 | cash flows, will illustrate everything that's going on in somebody's financial life and
00:34:29.400 | everything that can happen in the future in their financial life. So this will give you
00:34:33.580 | a really professional way to start. And I think if you start to learn these and start
00:34:37.200 | to implement them, it can make a dramatic difference. Thank you for listening today.
00:34:41.180 | I have enjoyed doing this. I hope this again, this is kind of down on the meat and potatoes
00:34:46.860 | side of financial planning. I'm really trying to strike a balance here with not doing, with
00:34:51.940 | doing enough inspirational, you know, interesting interviews, but then also giving the nut and
00:34:57.860 | bolts tactics. And I hope that we're achieving that. I hope to get better at it as time goes
00:35:02.300 | on. This is one of my big beefs and that's why I'm trying to correct it, is that it doesn't
00:35:07.140 | do me any good to give you a list of tips and tactics, some of which may or may not
00:35:11.020 | apply to your situation. And it doesn't give me any, do any good to just give constant
00:35:16.340 | inspiration, inspiration, inspiration without giving, okay, what do I do to get from here
00:35:20.580 | to there? And so what I'd like to do is create these shows that will serve as a, as a basis
00:35:25.980 | for you to say, for me not to say, here's how you can cut or here's what you should
00:35:30.300 | do, but rather to say, here's how you can create your own financial statements. Here's
00:35:34.420 | how you can analyze them. And here are lots of neat ideas for solutions that you could
00:35:38.900 | potentially implement in your life that would help you to, to really further your objectives.
00:35:45.300 | So that's it for today. No fancy ending music again, I'm podcasting from the road and I
00:35:49.860 | haven't, don't have the equipment set up to be able to do this, but I figured I'd rather
00:35:52.820 | bring you a show than no show at all. So no fancy ending music, ending announcements.
00:35:57.100 | If you haven't, please consider leaving me a review. Love to hear any feedback that you
00:36:00.740 | had. Hope you enjoyed the interview yesterday. As far as the rest of this week, I don't have
00:36:05.180 | an interview lined up for tomorrow, so it'll probably be bringing you another aspect of,
00:36:10.260 | another aspect of a financial planning lesson. And then Friday we'll be doing a Q and A show
00:36:15.500 | again on Friday and next week we will hope to have more interviews lined up, working
00:36:20.780 | hard as I can to get those done. Just busy and challenging to get it all done. So have
00:36:25.340 | an awesome Wednesday, today's Wednesday, have an awesome Wednesday and I hope you enjoyed
00:36:30.100 | it and peace out.
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