Insights into the finances of public companies and nations are often best understood through financial analysis that calculates ratios. Whether you're BlackBerry or Greece financial analysts are most interested in a few key measures. Let's look at some of these key figures for your own financial situation and understand how we got them.
What does your financial situation taste like?
My younger brother recently received a Vitamix as a wedding gift. Vitamix is part of a new breed of super-blenders. They can make a nicely blended sauce, mill grain into flour, or even reduce your electronics to a fine powder. In short anything that goes into the blender becomes one common mush.
Today let’s send your personal finances through a super-blender. We’ll make a dipping sauce and see what comes out.
Making a tasty dipping sauce involves a set of decisions about which ingredients to use while considering how they will affect the overall taste. After throwing them all in a super-blender you get to taste your dipping sauce - before making adjustments. Personal finance is the same way. The correct balance of ingredients will deliver the appropriate flavour for your tastes. It doesn’t matter how you slice and dice each of your financial items individually - in the eyes of the super blender they’re all going to end up as a mush.
The world of personal finance is complicated. It involves a series of endless decisions about fiscal ingredients. Should I buy this? Should I invest in that? Should I open this type of an account? Should I borrow under these terms? When you answer these questions you are choosing the adjustments to your financial dipping sauce.
So what does your financial dipping sauce looks like right now? Follow these steps to find out:
- Write up Your Recipe
- List what you own on one side of a page and what you owe on another. I recommend you include at least all items valued over $10,000. Include you and your partner’s items as well as your stake in portions of company assets and liabilities. Your accountant would be appalled at this simplification but the info isn’t going to CRA. It’s going into a super-blender.
- List what your family earns on an after-tax basis (visit here if you need help)
- We OWN $________
- We OWE $________
- We MAKE $________
- Throw this info into a super-blender (figuratively – it won’t work otherwise).
- See what comes out:
- How much sauce do we have?
- Deduct what you owe from what you own.
- You’re WORTH $________ = OWN - OWE
- Money doesn’t buy happiness… but more is generally considered better in this category! Note: Having a lot of stuff doesn’t necessarily equate to having a lot of sauce.
- How spicy is our sauce?
- Divide what you own by what you’re worth.
- You’re LEVERAGED ________ times = OWN / WORTH
- The larger this number the spicier your financial situation is. A person who doesn’t owe anything will be leveraged by 1.0 (i.e. they’re not leveraged at all). A person who owes a lot comparatively might see the number 2.0.
- How long would it take us to de-spice our sauce?
- Not happy with your level of spice? Perhaps your income can help you out. Take what you owe and divide it by what you earn. This is the length of time it would take to get rid of all of your debts should you do nothing with your income but pay it off.
- YEARS TO DE-SPICE ________ = OWE / MAKE
- Does one of my ingredients overpower the others?
- Take the most valuable thing you own (e.g. home or business) and divide its value by your WORTH (how much sauce you have). This is the % of your worth concentrated in a single thing.
- You’re CONCENTRATED ________ % = MOST VALUABLE THING / WORTH
- Wait! That can’t be right; my house is worth way more than a 100% of my worth!? …Maybe not! This happens because of spice.
- When will our sauce give us heartburn?
- Take your WORTH (how much sauce you have) and divide it by the most valuable thing you own (e.g. home or business). You’re WORTH will be wiped out if the most valuable thing you own drops in value by this percentage.
- You’ll have HEART BURN if a ________ % drop occurs = WORTH / MOST VALUABLE THING
- When stuff changes value (i.e. the value of a house or business) a person with a spicy sauce will feel strong increases and decreases in their worth. 50% drops in the value of businesses, real estate, or stocks are not altogether uncommon. Awareness of what could wipe you out financially is important.
- How much sauce do we have?
So… do you like the taste? Or are adjustments in order?
The decisions about financial ingredients will continue - but as you make them ask yourself what affect these decisions will have on your overall financial dipping sauce. It has to match your appetite – financial indigestion awaits those who get it wrong.
Super-blend your finances periodically to make sure you’re on track.
Example: John and Jane
House in Vancouver
Cabin by the lake
Kids education plan
Jane’s consulting business if she were to sell it
RRSPs at the bank
TFSAs at the credit union
RRSP with Jaime’s friend (can’t remember his name)
Cousin Peter’s real estate partnership thingy
Cars and other sellable stuff
Mortgage on the cabin
Line of Credit
Jane’s business line of credit
Money borrowed for cousin Peter’s real estate thingy
Total after tax
$143,000 before tax
$143,000 before tax
$200,000 after tax
We OWN $1,500,000.00
We OWE $1,000,000.00
We MAKE $200,000.00
- We are worth $500,000.
- We are leveraged 3 to 1 (3 times).
- It would take 5 years worth of all of our income in order to pay off our debts through income.
- Our house accounts for 200% of our net worth.
- A 50% drop in the value of our house would wipe out our worth!
- A 40% drop in the value of all of our real estate would wipe out our worth!
Written by Ian Collings