What I Taught My Accounting Students That Could Help You

I’ve been teaching Accounting and Personal Finance courses for the last twenty years and have learned that there are many similarities between the two. There are tools, techniques and financial thinking processes from business accounting that you can apply to your own finances.  Things like income statements, balance sheets, and accrual based accounting have real practical implications for everyday money management that you can use.    

Income Statement/Budget

In business, the most crucial measurement is how much income (or profit) the company is generating. We use an Income Statement to measure the difference between money coming in (income or revenue) and money going out (expenses or costs).  The resulting number indicates whether the business is making or losing money. The obvious goal is to make money and not lose money.  For your own personal finances, the same goal applies: you want to make more money than you spend and you can do that with a budget statement.

How To Create A Budget

There are two steps to creating a budget: gather up all your sources of incoming money (income) and all your outgoing money (expenses).  Create a spreadsheet or use an app, like Rocket Money, to track and calculate your budget (Total Income - Total Expenses). Here’s an example of what a budget worksheet looks like:

Let’s take a look at the various types of income and expenses you should account for.

Tracking Income

There are several major categories of income.

1. Wages and salaries: this includes all the money you make from jobs
2. Investment income: money from savings and investments accounts
3. Gifts: any cash gifts you receive
4. Other: income from things like alimony and child support

Tracking Expenses

As far as expenses go, there are a wide variety that you should track and manage.

1. Housing: mortgage or rent, property taxes, HOA fees, household repairs
2. Auto: loan or lease payments, gas, repairs, maintenance
3. Food: groceries, restaurants, pet food
4. Utilities: electric/gas,water, internet, cable, phone
5. Clothing
6. Medical: insurance fees, co-pays, prescriptions, dental care
7. Insurance: homeowners, auto, life, disability 
8. Household items: basic supplies, shoes, clothes
9. Savings/Retirement: emergency fund, retirement investing, savings
10. Entertainment: movies, concerts and miscellaneous fun things

There will be other expenses that don’t fit into any of the categories, so make sure to include everything that you can.   When working on your budget, it’s really important to keep track of every source of income and every expense, otherwise you won’t have an accurate picture of your financial standing.

Balance Sheet/Net Worth

In accounting, we track how much a company is worth with a balance sheet.  The balance sheet lists all the assets (what you own) and the liabilities (what you owe).  When you subtract the two, the leftover is called shareholder’s equity, which is what the company is worth.  For individuals, the same concept is called your Net Worth and is calculated exactly the same way.  Your assets minus liabilities will tell you what you are worth.  If your liabilities exceed your assets, then you are essentially bankrupt.  Let’s take a look at a balance sheet of a fictitious family:

Assets (What You Own)

• Checking & Savings: $15,000
• Retirement Accounts (401k/IRA): $45,000
• Investment/Brokerage Account: $10,000
• Home Market Value: $300,000
• Vehicles (Current Trade-in Value): $15,000
• Total Assets: $385,000

Liabilities (What You Owe)

• Remaining Mortgage: $200,000
• Auto Loan: $10,000
• Credit Card Debt: $2,000
• Student Loans: $15,000
• Total Liabilities: $227,000 

Net Worth

$385,000 (Assets) - $227,000 (Liabilities) = $158,000 (Net Worth)

Accrual vs. Cash Based Accounting

In Accounting, there are two ways of tracking your income and expenses.  The first is called accrual based accounting.  The way it works is that you keep track of income and expenses as soon as they are incurred.  In other words, as soon as you know that you’re going to have an income item or expense, you should account for it, even if you haven’t received or spent the money yet.  The ​​other technique is called cash based accounting, and it works by keeping track of income and expenses only when you actually receive the money or spend it.  Most companies use accrual based accounting, and so should you, because it gives you a more accurate picture of your net income.  That’s because your cash flow does not reflect any future income or expenses that you know are coming.  It just reflects how much cash you have at the moment, which is not an accurate picture and makes it difficult to plan properly.  For example, let’s say you have the following situation in month:

1. You paid out $1,500 in expenses in cash
2. You have outstanding bills of $965
3. You received $4,300 from your paychecks
4. You expect to receive an additional $1,200 in gifts from a side business you run

Under the cash basis, your income is $4,300 - $1,500 = $2,800

Under the accrual basis your income is $5,500 - $2,465 = $3,035

From this example, you can see how different the two numbers are.  The accrual basis is a much more accurate way of determining your net income.  You can do this by keeping track of all actual and anticipated income and expenses.  Don’t rely on how much cash you have in the bank or around the house to calculate your income.

Think Like A Business/Accountant

We can learn a lot from how businesses and accountants think.  There are many principles and concepts that can help you manage your day to day and long term finances, if you “think like a company”.

Cash Flow Matters More Than Income

Even more important than tracking your net income, cash flow can make or break a business and your family’s finances.  What is it?  It’s simply the pace of money coming in vs. going out.  Ideally, your money coming in is faster than going out.  You don’t want to live paycheck to paycheck, otherwise you might start eating into your savings and end up in a stressful situation.  It’s important that the flow of money is always positive and that you don’t end up paying for more expenses than money coming in at any given point.

Small Expenses Can Become Big Problems

While they might seem innocuous, your small expenses can add up over time and eat into your income more than you think.  For example, if you buy a $5.25 cup of coffee every weekday, that adds up to $26.25/week, $105/month and $1,260 per year!  All your subscriptions, streaming services and delivery fees can add up quickly too.  Make sure to keep on top of all of these and cut back where it makes sense to save money.

Debt Is A Powerful Tool That Can Become Dangerous

Borrowing money has its place, but can easily spiral out of control. Used wisely, it can help you make big purchases like homes and cars or aid us in making purchases.  If you’re not careful, you can take on more debt than you can afford.  Credit cards in particular can be dangerous as they make it so easy to buy things that we don’t have cash for.  But you should only buy what you can afford and make sure to pay off credit card bills in full every month so you don’t accrue interest charges.

Conclusion

There are many lessons that I’ve taught in my Accounting classes that can be applied to individual financial management.  If you apply these techniques to your own personal situation, you can smartly keep track and manage your income and expenses.  Treat your family’s money as if you are running a business trying to make as much profit as possible.

Make sure to check out other great articles about money management and ways to save, including:

20 Ways To Save Money As Part Of Your Daily Routine

How To Create and Stick to A Budget When Money Is Tight

Sneaky Pricing Tricks Companies Use on You

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