Understanding Personal Finance: Household Budgets, Key Ratios and Investment

With the Union Budget just around the corner, finance realms are filled with analyses, wishlists, and recommendations. It takes almost an entire week to release and understand the final verdict. As the effect of the budget trickles down, every month, every quarter, further analyses are made. However, we tend to overlook the budgeting and fiscal health of our household, which could have a more direct impact on our lives.

Personal Budgeting: The Overlooked Art

Ask yourself, do you prepare a household budget and track it throughout the year? Do you evaluate the result and plan accordingly? Do you understand your own balance sheet? What’s your deficit and how are your investments in income-generating assets? If you are unsure about these questions, you may need to rethink your personal budgeting ways.

Most people do some level of planning. However, its depth is often questionable, and in most cases, insufficient. Although creating detailed, accurate budgets could be laborious, maintaining a proper understanding of the household “balance sheet” is crucial. When this is done right, the profit and loss (income and expenses) will likely improve and track better.

Understanding Balance Sheet: The Asset Side

When it comes to the assets in your balance sheet, answer these key questions:

1. How is your wealth invested across assets? Is it aligned with your goals?

Right asset allocation is the key determinant of long-term wealth accumulation. Allocate assets as per goals and have a specific financial target to achieve. This target could change with time, but a goal gives a sense of direction to work towards.

2. Do you have sufficient liquid assets to meet near-term needs?

Have an emergency fund and set aside funds for upcoming expenses in advance to prevent the liquidation of investments due to any unexpected need.

3. How do you treat your so-called assets like “cars/vehicles”?

While accounting rules may consider these as assets, they are actual fast-depreciating commodities. They are best excluded from the assets side of the balance sheet.

Understanding the Balance Sheet: The Liability Side

Let’s focus on liabilities too:

1. How many loans do you have, and how much do they cost?

In today’s world, most individuals have multiple loans – home loans, car loans, credit card debts, or even personal loans. While these surely ease the buying process, they effectively eliminate savings. Keeping track of loans and their costs can help better savings and asset accumulation.

Understanding Fiscal Deficits and Primary Deficits

A solid grip on your balance sheet requires tracking two key ratios – fiscal deficit and primary deficit.

Fiscal deficit is the difference between total yearly income and total expenses for a year. If you spend more than you earn, you effectively borrow to fill the fiscal deficit gap. The higher the deficit, the more the borrowing, which is not financially sustainable in the long term.

Primary deficit is the fiscal deficit minus any interest payments that need to be made. If a deficit remains even after removing interest payments, it implies the borrowing of money for interest payment, indicating a troublesome financial cycle.

Analyzing your personal balance sheet in terms of net assets (assets less liabilities), wealth in units of gold for real wealth-creation sense, etc., can give profound insights into financial health. Tracking these can give a good sense of your balance sheet health.

In the end, the focus should not just be on budgeting but also on understanding key financial aspects to make informed financial decisions.

This content was brought to you by Reader Wall. Always consult your personal investment advisor/wealth manager before making any decisions.