Running yourself like a company - Income statements

22 Jan 2014 
SOURCE: La Papillion
You should run yourself like a company. There are certain beneficial practices in running a company that we can learn from. There are 3 important reports that can determine the state of the health of a company. These are the balance sheet, the cash flow statements and the income statements. A company needs to have these reports generated so that the managers and also the investors can have a look at whether the company is doing well and also for transparency, good corporate governance and accountability. This should also be the reason why you should do up your own personal financial statements so that you can see if you're doing well financially or not.

Of course, before you can even prepare such statements, you need to keep records. Since you're not listed nor fall under ACRA, you don't have to follow any accounting guidelines nor will you be fined for not meeting standards and regulations, as is the case for public and private companies. Feel free to include or exclude things that don't help you. The first step before you can improve your own situation is to take stock of where you are now. A good record of your financial situation, which involves keeping track of your income and expenses, will allow you to analyse how healthy you are financially.

I've prepared a sample of what a personal income statement looks like in a 3 months period from November to January. I think doing this on a monthly basis is good. However, there are some months that you spend more or less, depending on the holiday season and the variability of your income stream and expenses calender, so you can also consolidate the monthly in quarterly or semi-annually too, to even out the odd months. The statements are really prepared for yourself, so feel free to do anything that makes sense to you.

This is just an example of a personal income statement. The categories for expenses might be useful for your reference though.

In the income statement for a company, you look at the top line, i.e the revenue. This is equivalent to your total income streams coming either from work that you do or money working for you. Then we have to look at the expenses. Some of them are fixed, some are variable. If you take the revenue minus off the expenses, you'll get the gross profit before tax. That's also your savings if you minus your expenses off your income. After paying taxes, what's left will be your net profit for a company. That's your net savings per year. And this is ultimately what counts at the end of the day, not your gross revenue.

You can further crunch the numbers in the personal income statement to see the following:

1. Percentage change in income (equivalent to % change in revenue)

2. Percentage change in expenses

3. Your savings ratio, which is net savings as a percentage of income (equivalent to profit margin, which is net profit over revenue)

4. Expense ratio, which is total expenses as a percentage of income

Different companies doing different industry will have different profit margin. You can't expect a company in the service industry to have the same profit margin as a manufacturing one. Likewise, different person will have different savings ratio. It depends on how 'light' or how 'heavy' that person's burdens are. Just like there's no meaning to compare the profit margin of a property developer company to that of a shipping company, there's also no meaning to compare the savings ratio between different people. The better way to compare is to compare your own performance metrics across different time periods of your life. For example, you can compare your % income or savings ratio between the year 2008 and the year 2009. The competition should be directed internally, not externally. In other words, you should compare how you do now against how you did in the past, not between how well you do against how well others do.

Remember that savings is like the net profit of a company. You do not want to invest in a company that shows ever increasing revenue but stagnant or decreasing net profits margin, neither do you want to become a person with increasing income but decreasing saving ratio!

A good personal income statement should have the following characteristics:

1. A stable income that is high enough to cover the expenses and then more. This will ensure that there will be some excess left over for savings. Savings is the first step to let your money start working for you. There's no other way that a self-made person can make money work for him without having savings in the first place.

2. Increasing income and decreasing or constant expenses. What's important is not the absolute but the relative. Preferably, the income should increase over time while the expenses are kept constant or increases at a lower rate than the income.

3. Consistent and increasing savings ratio. Savings is all that matters at the end of the day. You work for an income to get the savings; all other expenses can be treated as cost for getting the savings. If you cannot have some savings, you need to increase your income or decrease your expenses. There's no other way around this.

Interestingly, I can imagine a retiree who is not working any more but is drawing down on his assets accumulated over his working years. In such a case, his personal income statement will look extremely unhealthy, with very little revenue on the top line and negative balance each month after subtracting off expenses. But such a person is like a holding company (a company that does not provide a service or produce goods). So, to see if such a company is a good one to invest, you look at the balance sheet and see what kind of assets and liabilities that he owns. I'll talk about balance sheet next in my future posts.

In essence, whatever is described above is really just for a growth company, defined as a company that produces goods or provides a service, and seeking to grow its profits. This is similar to a person who is not retired yet, and not drawing down on his accumulated earnings/assets.

Maybe next time before you get married, you should ask for a person's personal income statements before you choose to invest in him/her LOL

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