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Calculating Your Financial Health

5 Steps to Calculating Your Financial Health, and Why Its Important

Calculating your financial health is an often skipped step on the staircase of opportunity. Reviewing your assets, earnings and spending is not exactly exhilarating for most people. But to get where you want to go you should know where you are. And with a clear understanding of your financial condition, controlling your spending becomes effortless.

5 steps to Calculating Your Financial Health

Step#1 to Calculating Your Financial Health: Evaluating Your Income

Most people think of their gross income, when considering how much money they make. That’s fine if you’re willing to subtract out all of your pre and post-tax withholding as expenses. But to simplify this process, lets just start with net-earnings, the amount of your take-home pay, on a monthly basis.

If you’re not salaried, simply add up all your real earnings within one month or take an average of several months. If you’re paid on an hourly basis you can figure your monthly earnings by multiplying  your hourly rate by your pay-period. Semi-monthly pay periods cover 86.67 hours per pay period, typically paid on the 1st and 15th of each month. Bi-weekly pay periods occur every two weeks.

Once you know your monthly take-home pay, you can move on to the next step of evaluating your necessary expenses.

Step#2 to Calculating Your Financial Health: Your Necessary Expenses

Your necessary expenses, include everything you need to survive and maintain your quality of life. Despite what a lot of my client’s might report, necessary expenses do not include restaurants, vacations or luxury vehicles.

Necessary Expenses Should Include:

  • Housing and Utilities
  • Food and Clothing
  • Vehicle Operation and Maintenance Costs, or Public Transportation
  • Court Mandated Costs (Such as Child Support and Alimony)
  • Debt Repayments
  • Child Care Costs
  • Health Costs including insurance and out-of-pocket expenses
  • Taxes (if using your gross income in step #1)

To account for your necessary expenses. use an average of at least three months of your real, paid expenses as reflected on your monthly bank statements.

Now that you know your necessary expenses, lets look at disposable income.

Step#3 to Calculating Your Financial Health: Disposable Income

Disposable income is all the money you have left over after all of your necessary expenses are accounted for. If you use a long enough time period to average your figures in the first two steps, you can account for atypical or unplanned expenses as well.

Disposable Income = Net Income – Necessary Expenses.

By utilizing this simple equation, DI= NI – NE,  as it relates to your finances, you can form a solid basis for evaluating opportunities for increased savings. Conceptualizing your finances in this way will also naturally motivate you to earn more.

However, your income and expenses are only half of the picture. In order to really calculate your financial health you must also consider your equity in assets.

Step#4 to Calculating Your Financial Health: Equity in Assets

Equity is the portion of your assets (homes, cars, investments etc.) that you own. Unfortunately, with many assets this calculation can get a little tricky as the value of your assets are ever changing.

For instance, if you’re paying off a vehicle, your equity is equal to the total payments you’ve made towards the current value of the car, not the loan. If the loan amount is higher than the current value of your car, you’ve got no equity, just debt. Thus, to get a true picture of your equity in assets you need to find out their current fair market value. You can easily get a rough estimate of your car’s value using Kelly Blue Book and your home’s value can be assessed by your county or on websites like Zillow.

To take it one step further, even if you know your equity in assets, that doesn’t necessarily tell you how your assets translate into liquid cash. Generally the best way to convert your equity into potential cash, is to multiply the amount by .80, to determine the Quick Sale Value.

For example:

Vehicle Loan:$15,000
Total Payments to Date: $5,000
Vehicles Current Value: $7,000
Equity: $2,000
Quick Sale Value: $5,600

The Quick Sale Value is the amount you could reasonably expect to receive if the asset were sold at a bargain…quickly.

Step#5 to Calculating Your Financial Health: Calculating Net Worth

Finally, to arrive at your net worth you just have to add your equity in assets to your cash holdings (bank accounts, investments and cash-on-hand) and subtract out any debts.

For instance:

Current Value of Checking Account$10,000
Current Value of Investments$20,000
Equity on a car worth $7,000. You owe $9,000$0.00
Remaining Vehicle Debt$9,000
Net Worth$21,000

 

When taking all of these factors into consideration you’re left with a simple but effective look into your financial health. With a full comprehension of your income, expenses and what you have to work with you can far more easily adjust your spending habits, evaluate opportunities and focus on ways to increase your earnings.

How healthy are your finances?

2 thoughts on “5 Steps to Calculating Your Financial Health, and Why Its Important

  1. Some of the “necessary” expenses that I kept forgetting to take into account when we were doing our annual budget, was Car Insurance (since we pay that bill biannually) and then city-utilities (since I have them auto-charged to my bank account) and utilities tend to fluctuate based on season. So I really like the idea of taking an average of at least 3-months’ statements as described in #2. I feel like a lot of people fail to budget appropriately because of the same over-sight I committed for a long time.

    1. Those are good points Matt. I like to look at an annual, personal P&L to get a good sense of my necessary expenses and how they change over time. Also, I’ve found that keeping a Mint or Personal Capital account can help compile this data easily!

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