Personal finance is an activity that involves all the individual financial decisions, which includes budgeting, saving, insurance, mortgages.

article image

For kids, personal finance is all about the coins in the piggy bank. For adults, personal finance means so much more. If one’s money stays in the current account without any financial activity, its value shrinks against inflation or other kinds of financial factors. In all history, people try to accumulate their wealth. Bad personal finance decisions can cause bankruptcy. So how can one accumulate personal wealth and make correct financial decisions? In this thesis, the author will explain about personal finance and current common financial products and activities.

Financial planning is a way to financial security. It helps people to reach their personal goals. A financial plan sets a journey from present condition to the desired objective. The process of financial planning in general consists of five steps.

Step 1: Gathering information and evaluating current financial situation

A financial plan starts with a thorough evaluation of one’s current financial circumstance. How much income does one have? How much expenses does one have? How is one’s expenditure allocated? How much loan does one have? Before mapping out the steps, an individual has to see his or her whole financial picture, which demands him or her to keep track of spending carefully. In order to do so, he or she can take a few minutes every day to log in all the daily spending into a book, a computer program, or even a mobile application.

Net Worth and Balance Sheet

To view one’s entire financial picture, an individual must find out his or her general situation by applying the concept of net worth. This concept helps individuals to categorize their assets and their liabilities. Asset is what one owns. It can be money, investments, real estates, cars, paintings, etc. Liability is what one owes, like mortgage, student loan, credit card debt, money borrowed from somebody and so on. By subtracting the sum of liabilities from the sum of assets, one will get one’s net worth.

Cash flow, saving and income statement

As it is shown above, a balance sheet provides general information on one’s financial situation. However, if an individual wants to trace his money and learn more details about his personal finance, he will need a tool called income statement. An income statement shows where one’s money comes from and where it goes in an assigned period. An income statement is also called cash flow statement, in which income is the cash inflow and expenditure is the cash outflow.

Step 2: Setting financial goals

Financial goals can be anything, such as a phone, a trip, a wedding, a house. In some countries, individuals also need to save for education and retirement. Individuals should know where they are heading before they set out. Besides defining a financial goal and attaching a price to it, individuals should also determine how much time they need to accomplish the goal. Every goal has its own time axis ranging from weeks to many years.

Step 3: Developing financial plan

A decent financial plan is well-designed, which matches one’s personal goals. Flexibility, liquidity, protection and tax are all ought to be taken into account. For example, Antti lost his job all of a sudden and yet, he still had a mortgage to pay. He had some saving in the bank. However, his saving is under a fixed-term investment. In this example, flexibility is about planning for the unexpected. Antti should prepare some saving for periods of interrupted income. Liquidity means the availability of one’s money when needed. Although Antti did have some saving in the bank, he couldn’t access it. In Finland, Antti has Kela (the Finnish social insurance institution) support, protecting him from unemployment. In many unpredictable events, insurance can protect people from financial security threats. However, insurance costs. Therefore, a solid financial plan must contain sufficient insurance to keep off financial disaster. In the end, tax must also be considered in the financial planning. After all, part of one’s income goes to the government.

When individuals have made their financial plan, they should think about the following questions.

  • Do I have enough liquidity when emergency occurs?
  • Can I fulfill my debt obligations, like mortgage and credit card bill?
  • Do I save as much as I expect?

Month’s living expenses covered ratio can show how many months one can survive in the event of loss of all current. The living expenses do not contain tax and savings. A ratio of 3-6 is preferred. It suggests how many months one should get a new job.

Personal budget

A personal budget is an excellent tool for monitoring if the actual financial activity is going as one has planned and how the expenses are allocated. It can help individuals to spend less by arousing their awareness of additional spending. A personal budget is a finance plan that determines the distribution of future income towards spending, saving and investing. A personal budget is made based on the past expenses and personal debts. When one is making his personal budget, he should try to keep it simple. A redundant personal budget tends to make a person to give up during the process. For instance, identifying the income and expenses does not need to be too specific, a user should categorize more generally. Flexibility is another tip that one should keep in mind. Because some spending does not happen every month. Like people may spend more money on ice cream in the summer time than in the winter. The variation in budgeting needs to be made accordingly.

Step 4: Implementing the plan

Financial plan is more like a map than a goal. It is a tool that leads to the goal. It is important to follow the plan. During the journey, one should keep tracking his income and spending and meanwhile pay attention to the long-term goal. Based on the changes occurred in the journey, he can renew the route to the final destination. What matters the most is that he keeps moving towards the goal, not giving up in the middle if something happens.

Step 5: Reviewing the implementation and revising the plan

As time goes by, things change. At the age of twenty, one may concern about getting a job; whereas he turns thirty, he cares about housing, or his new-born baby. Individuals must review their financial plans and re-evaluate their financial situation accordingly.