Personal Finance can be understood by understanding what it is NOT.
Many people believe that accounting and personal finances are one and the same. However, Personal Finance is not Accounting.
They may appear identical on the surface, but they have something in common: they both have to do with money. The definitions will help you better understand the differences.
Merriam-Webster defines accounting as “the process of recording and summarizing financial transactions, and then analyzing, verifying and reporting the results.”
This definition shows that accounting is the act of recording and analysing what you’ve done with your money.
Personal finances are often too complicated for an accountant.
Accountants don’t usually deal with personal finances, though there are exceptions to this rule. Unless your accountant is a financial coach or financial advisor, they will not be able to provide you with an analysis of your year’s finances.
This is your tax return. It shows you what you owe to the government and what the government owes.
Rarely does an accountant provide a person with a balance sheet, income statement or net worth statement. These are all valuable tools that can be used to manage your personal finances.
Personal Finance refers to a proactive and goal-oriented approach to your finances. This gives accountants something to verify, record and analyze.
According to Merriam-Webster’s Concise Encyclopedia, finance is “the process of raising capital or funds for any type of expenditure.” Businesses, consumers, and governments are often short of the funds they require to purchase or operate. However, savers and investors can have funds that could be used to earn interest and dividends. Finance is the transfer of funds from savers into users. This can be in the form credit, loans or invested capital via agencies such as COMMERCIAL BANKS and SAVINGS and LOAN ASSOCIATIONS and other nonbank organizations like CREDIT UNIONS, investment companies, and other nonbank organizations. There are three main areas of finance: BUSINESS FINANCE and PERSONAL FINANCE. All three require the creation of budgets and management of funds to achieve optimal results.
Simpler Personal Finance
Understanding the meaning of “finance”, we can easily break down our “personal finances” into three simple activities:
1. It is the process of raising capital or funds for any type of expenditure.
The sale of products or services can make a business money. This is called “revenue” (or “income”). Businesses may also decide to invest some of their revenue in order to generate additional income (interest income).
One can make money by working, or starting a small business (self-employment, sole proprietorship or network marketing, or any other type of small business venture). Income can refer to a person’s income as a salary, an hourly wage, or a commission.
The taxes we pay are the main source of money for the government. This is the primary way that the government generates income. It then uses that income to build infrastructure such as roads, bridges, schools and hospitals for our cities.
2. Spending money is using our money to buy things.
The difference between having optimal results and not is how much you spend relative to how much you make. No matter how much money you make, making good spending decisions is key to financial success.
3. Maximizing your results means retaining as much of your money as possible
When it comes to personal finances, it’s not what you make that matters. It is how much you KEEP.
This is the most difficult part of personal finance.
People with high incomes (often six figures or more) tend to also spend more. This means that they end up in debt and the interest starts accruing. This debt can quickly grow rapidly and destroy any chance of achieving financial freedom.
Simple Personal Finance
If you follow this simple formula, personal finance doesn’t have to be difficult.
INCOME = SPENDING = WHAT YOU KEEP
You can get optimum results by spending less and making more.
You will get less than optimal results if you don’t actively work towards achieving it.
It’s that easy!
Once you have a good understanding of personal finance and what you should do, you can now learn HOW to do it!
These are the best steps to follow:
1. You must know what you want. Stephen Covey’s book, “7 Habits of Highly Successful People” highlights the importance of starting with the end in your mind. It is important to know where you want it to be.
2. A plan is a roadmap that you can use to get to your goals. It is important to know how you will reach your goals. Sometimes, this is easier if you have a financial coach or advisor.
3. Make use of tools and resources to help you stick to your plan. This will allow you to not be distracted by things that might limit our income or make us spend more than necessary. Do not try to figure it all out on your own! It will lead to a lot of headaches and will cause your finances to become a huge dark cloud.