Understanding your financial situation

How much can you invest? Where can you find the money? Understanding your financial situation helps you answer these essential questions.

We will show you how to apply some really helpful tools to understand your financial situation. First, we’ll talk about your financial situation and about how to check your own financial performance. Secondly, we'll show you how to check your financial position and financial capacity.

Why study your financial situation?

When engineers plan a bridge, they want it to last, to stay strong over many years despite the heaviest traffic and worst weather. When you plan to invest, you also need to maintain a sound financial situation even during unexpected financial demands or poor market conditions. That way you can stay the distance and stick to your plans.

Studying your own financial situation will help you understand the demands you can make on your finances without toppling over.

To check your financial situation properly, FIDO recommends two tools used all the time in looking at investments:

Your financial performance, which looks at your income and expenses over a whole year, often called a profit and loss statement and
Your financial position which looks at your assets and liabilities at a single point in time, often called a balance sheet.

Your financial performance

Are you a saver or a spender?

Does your income exceed your expenses?
Are you personally making a profit or a loss?

Your financial performance sums up your income and expenses over a period of time, usually a year. FIDO suggests you use the financial year 1 July to 30 June, because that probably ties in with your tax return and most superannuation statements.

FIDO's budget plannerlets you look thoroughly at your financial performance, so just download the planner and find out how much you saved over the past year. Be honest with yourself, especially with your expenses.

Let's assume you've done that. Now you need to dig a little deeper into the information.

Look at your income

Unusual items. If your income included money you don’t expect to receive in normal years, consider taking that income out of your budget to see if your normal income is more or less than your expenses.

Trends
Is your income trending up or down? Did your income go up or down compared with the year before? What do you think will happen this year? Over time, most people manage to get some increase in their income to catch up with inflation. On top of that, you may be progressing in your job, getting promotions or bonuses. Usually younger people can look forward to increasing their income this way. If your income is trending down, then you may have to be more careful.

Where’s your income coming from?
Your regular job probably makes up between 90-100% of your income.

If more than 10% ($10 in every $100) comes in from other sources, record it separately. Examples could include a second job, government benefits, maintenance payments and contributions for household expenses, rent or dividends.

How secure is this income and how long do you expect it to last? If it’s not reliable, consider treating it as unusual, and adjust your budget.

Look at your expenses

Unusual items
Looking ahead, do you have any plans such as buying a house, having children or educating them, taking an overseas trip, that are likely to increase your expenses more than simply the cost of living? Estimate how much they might cost and roughly when they may occur.

Trends
Unfortunately many people tend to increase their spending when they get a pay rise. Is that happening to you?

What’s costing you money?
Look for items you may be able to control. Check what you pay as interest on credit cards and personal loans. If you get a few unpleasant surprises about how much you spend outside the basic essentials, read FIDO’s budgeting tips.

Lurking expenses that bite
What about expenses to repair and replace your house, car and expensive household goods that you may not have occurred this year, but will occur in future?

To help you plan for major expenses like these:

estimate the useful life of the item in years. (An older house might last 30-40 years, a new home unit 20-30 years, a new car 10 years. Note: For buildings, we are assuming a useful life if never repaired or renovated.)
divide the cost of the item by the number of years to get a yearly cost. (With a house, just consider the cost of the building, not the land.)
charge yourself that cost each year as a 'depreciation' expense. So if building an older house would cost $200,000 today, divide by 40, giving $5,000 per year.)

Even if you do not actually have to pay cash that year, you have recognised that the expense will arise some day and you won't have overestimated what you can save, and possibly invest.

Your financial performance and investing

How much can you invest? Your financial performance shows if you have surplus funds. The stronger your financial performance, the more you can consider setting aside to invest.

Successful investing can usually start only when you spend less than you earn, and can look forward to a reliable, steady flow of extra cash.

Plenty of people on modest incomes have made themselves financially secure or even quite wealthy, while many high incomes earners just spend every cent on lifestyle and have nothing left over.

Two warnings

If you find your financial performance could support investing, remember you still need to consider your financial position and your overall financial capacity.

Watch out if your own financial performance is going backwards. Some warning signs:

Things get really tight just before pay day.
You need your credit card to finance your living expenses, not just to save you the bother of carrying cash.
You borrow money from friends or family just to make ends meet.

Investing money in this situation can prove a dangerous gamble. You may be better off getting your finances in better shape.

Now you've assessed your financial performance we'll show you how to check your financial position and your financial capacity When you've done this you'll understand your financial situation and be able to work out how much you can afford to invest.

More about investing

FIDO Website: Printed 09/07/2010