Why Prepare a Personal Income Statement?
Preparing an income statement will answer a very important question – Are you spending more than you are earning? In addition, a personal income statements offers the key to understanding your current financial spending and where you can make positive decisions to improve your situation.
It is the starting point whenever I begin when working with a client. An income statement tells the story of your current spending habits.
This article will further address how to prepare a personal income statement. It is one of the three statements (net worth and cash flow are the other two) that everyone should know how to prepare in order to better understand their finances.
What is an Income Statement?
Before we go any further, let’s define what I mean by an Income Statement. It’s a listing of your take home income less all of your expenses by month. The net difference should be close to zero or a positive number. If the result is negative, it means you are spending more than you are earning or some rare cases, you are saving more than you can afford.
To make it simple, include take-home pay (net pay after all of your deductions). This is the amount of money remaining that you can use for all of your spending and saving. Don’t forget to include child support, alimony, and any extra money you are making from your side hustle. Also, include dividends and interest, if they are significant (over $50/month).
This needs to include every dollar that you are spending. It does not need to include automatic deductions from your paycheck. If you choose to, I suggest, listing these amounts directly under your income and not listed as expense items.
I also suggest that fixed and variable expenses are segregated with their own sub-totals.
- Fixed expenses are all of your weekly, monthly, quarterly, and yearly obligations. Examples are your rent or mortgage, cellphone service, cable bill, and monthly auto insurance payments.
- Variable expenses are all your other expenses. Do not forget to include any cash that you withdraw from your ATM.
A Personal Income Statement Reveals Your Current Spending and Saving Habits
Once you have all of your spending and income listed by month, it can be quite shocking. The amount you are spending in some categories may truly surprise you. I have had clients say to me that their spending is “over the top”. One client was horrified when he realized their grocery spending was almost $1,400 per month and they are a family of two adults! Another, spent $14,000 in a year on clothes for their two girls who were attending private school that required uniforms. (The cost of the uniforms was not included in the $14,000!)
What To Do After You Prepare Your Income Statement
First, make sure that you are capturing all of your spending. It is fairly common to forget about many expenses. I recommend that you keep track of your spending for several months, since frequently your income and spending will fluctuate. You will get a clearly idea with several months of data.
The next step depends upon what you are trying to accomplish. If you are spending more than you are making, you will need to decide what you can cut or reduce. If you are trying to pay off consumer debt, then you might need to seek additional income along with reducing your spending.
A personal income statement is a starting point for anyone or any family that is trying to better understand their financial situation. It will reveal whether you are spending more than you are earning and thus answer the question: “Why am I (we) not able to save?”
Have you prepared a personal income statement? Did you learn anything useful?