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I got my first credit card at the age of 19. When I moved to California for college, Bank of America had a stand at the orientation fair.
I lost my debit card, so I popped by. The conversation went something like this:
- I need to get my debit card reprinted.
- Sure! Do you want to get a credit card too?
- Hm… I’ve never thought of that. I am not a U.S. citizen either way.
- That’s no problem.
- Well, don’t I need to pay some crazy interest rate?
- No. Your first year is 0.0% APR.
- Wow! So I can pretty much get this card, use the money for the entire year at no cost at all?
- Yep! In addition, this card will pay you 3% cash-back on all your purchases.
I thought: Why not. Having access to capital for free is cool. I don’t need to use it. But it’s cool to have it rather than not. There is no risk.
I saw down on a plastic chair on the street and filled out the form. It took me around 10 minutes to apply for my very first card in my teens with no job, Social Security Number, or green card.
The card arrived in a week. The 3% cash-back perk made me prefer to use my credit card for all purchases over my debit card.
For the first ~6 months, I was pretty responsible with my credit card. I’d never spent more I had. Then I started buying things ahead of time on the credit card. If I was expecting to get $1,000 deposited to my account in a week, why should I have waited a week? I could buy things before the money arrived.
That was mistake #1: spending more than you earn. Before I had a credit card, it was not even a thought. It was literally impossible to spend money that you didn’t have.
I financed business trips that I thought would pay off nicely. I did meetings and dates at Michelin-star restaurants. I flew around excessively.
A few years later, I racked up $30,000 in credit card debt.
Turns out that those credit cards that are handed out like flyers have 20%+ APR (annual percentage rate). I started paying $6k+ / year just in interest payments.
Looking back, I feel a bit scammed. My financial choices were no doubt… terrible.
And yet, giving teenagers a 5-figure credit line?
I went to one of the top Universities in the world majoring in business. I aced my finance and accounting classes. I grew up in a frugal family of entrepreneurs.
And I still felt into the trap.
Turns out, I am not the only one. American culture has a very unhealthy relationship with debt. 84.6 percent of new vehicles purchased in the U.S. are financed. The majority of real estate is bought on credit. You can finance almost any purchase on Amazon. Not to mention student loans, which you are obligated to pay off no matter what. Americans have close to $14 trillion in debt today.
One of the all-time greatest boxers, Mike Tyson, filed for bankruptcy having made $400 million over his career! He did buy tigers, diamonds, and other extravagant things. His lifestyle cost him over $400,000 / month.
Tyson is not alone though. “78 percent of former NFL players experience financial distress two years after retirement.”
Not all debt is evil. What’s terrible is the lack of financial education and the institutions that take advantage of this.
In this article, I introduce principles and tactics to master personal finance by creating personal financial statements just like a business would. My approach is based on the following assumptions:
Thus, one must treat his/her wealth and finances as a business.
This article will provide essentials to 1) gain clarity about the wealth-building principles 2) templates to understand YOUR finances & build your financial strategy.
You don’t need to have a college degree or be a numbers nerd to gain value out of this article. All I ask of you is to question what you know about money.
I got burned financially early on. I also had a really hard time finding resources to understand my own finances. This article is written for the most part for me to document what I know. There are no affiliate links, product placement, or incentives whatsoever. Enjoy.
A business is defined as an entity engaged in professional activities to generate profit. Businesses own assets. Businesses can invest their cash balances into stocks. They can be sued in court. Businesses pay taxes.
And so can individual people. Throughout your life, you will engage in exactly the same activities as a business would. Why not follow systems designed to do those things well? A multi-trillion-dollar economy is based upon these principles, surely the approach must be pretty darn good.
There is a slight difference between persons and businesses. The success of a business is determined by the profit it generates. Whereas, the success of our lives is measured by our happiness and fulfillment. Those goals are abstract and vary from person to person.
While businesses set goals for long term profit maximization, one shall set lifestyle goals. In other words, instead of measuring milestones in millions of dollars or Lamborghinis (the what), it’s more productive to think in terms of the way we want to live (the how).
If you were to do a consultation with a good wealth manager, the conversation would start dreamlining your lifestyle: when you want to retire, what University you want to send your kid to, where do you want to live, etc.. Only after the lifestyle goals are established will there be a conversation about your financial strategy.
Lifestyle and financial goal setting are beyond the scope of this article, but I do encourage you to think about how success looks like to you. Consider the trade-offs too.
Money will be just a tool to get what you actually want. Money is the opposite of “the root of all evil” from the old biblical propaganda (Timothy 6:10). Money will buy back your time so that you can spend more time with the people you love. It will give you the freedom of choice, so you can do more of what you are passionate about. And if something terrible happens, you will always be able to pay the medical bills and ensure your family is safe.
Mastering personal finance should be seen as a requirement to live your best life. Don’t let anyone convince you otherwise.
Thousands of years before writing was invented (8,000-3,000 BC), humans used clay tokens to keep track of ownership and goods. The first writing itself (3,400-3,000 BC), discovered in Mesopotamia, was accounting records.
Early rulers needed to keep track of transactions to collect taxes and enforce property law. Record keeping allowed early cities to grow, people to collaborate and our civilization to progress.
“What gets measured, gets managed”
- Peter Drucker
To navigate a map, one must know their current location. Otherwise, the map is useless, even if the destination is known.
Luckily, you do not need to re-invent the wheel to understand your current financial situations. Accounting has already created a uniform format for record-keeping.
We will use the essential three financial statements to understand where we stand financially now (point A) and then to plan how to get where we want to be (point B). We will use Generally Accepted Accounting Principles (GAAP) to ensure we don’t make mistakes. GAAP is the standard that allows everyone to speak the same language and identify mistakes quickly.
If you can read these three financial statements, you will be able to understand every single publicly listed company in the U.S.! How cool is that?
And the best part is that it’s pretty easy! It ain't rocket science.
The formula for wealth creation:
“Spend less than you earn—invest the surplus—avoid debt”
To build wealth, we need to either spend less or earn more. Investing the surplus allows you to earn more, whereas debt will rob you through interest payments.
We will track just two things. First, how much money you retain at the end of each month (earnings minus expenses). Second, your overall net worth (everything you own minus everything you owe).
The first tab of the spreadsheet, titled “Dashboard,” shows two graphs to visually display monthly cash surplus and your wealth. Those graphs get updated automatically as you edit the spreadsheet.
Businesses use three core financial statements. I’ve adjusted those for personal use and removed accounting jargon.
Here is a comparison of how financial terms translate into the personal ones:
The spreadsheet has notes that you can access by hovering over a cell. It’s not too complicated, I promise!
Very last note, before we dive into the three financial statements. The spreadsheet is very customizable for your unique case. For example, if you do not have a house or a car and you don’t plan to have those anytime soon, perfect! Just remove those rows. Alternatively, feel free to add rows where needed. Just play around with it and adjust the spreadsheet to your unique situation.
The Statement of Cash Flows allows you to understand your cash balances, when you receive money and when you have to pay for things.
People who live paycheck to paycheck are those who have to balance this delicately. Or not. In Latin America for example, it’s common to get paid on the 1st and 15th of each month. What many younger people do is party their money away in the first few days, and spend the rest of the period surviving on rice and beans. The cycle repeats every two weeks.
You can make more money than you spend, and yet be still unable to pay your rent at the beginning of the month due to timing. Typically you pay rent at the beginning of the month and your salary gets deposited at the end of the month.
There is no dedicated tab for cash flows in our spreadsheet. Instead, I like using a free app called Mint because we don’t have to keep track and categorize our transactions manually in a spreadsheet. It’s done for us automatically.
Here are a few things you can do:
Overall, I use this tool to watch how much I spend per category and how much money I get deposited every month (often done in multiple transfers). I then use this information for reporting in my Income Statement. Mint sometimes miscategorizes certain transactions, so you need to review those.
All in all, I spend about 10 minutes a month on cash flows.
Now, let's get back to the fun part. The most crucial part of the wealth formula is: make more than you spend.
An income statement will give the final, most important metric, net profit / loss. The more you have left at the end of each month, the better.
The structure of an income statement is very simple:
Revenue (your salary and other income streams)
Expenses (what you spend)
Profit / Loss (what’s left)
Residual Profit = Revenus - Expenses
Here is the full income statement:
∆ Change will show you how you are doing this month compared to the last. You shall use these numbers to create a narrative that explains what’s happening with your finances.
I’ve also included a category called non-operating. The idea is very simple. A lemonade stand business has its core operations. Revenues are lemonade sales. Expenses are the ingredients, markers, table, etc.. These revenues and expenses are associated with the core activity of the business - making lemonade.
We can quickly grasp how profitable this business can be. Non-operating are the things that are not directly related to running the lemonade business such as paying interest or reporting a “loss” when all lemons went bad.
I purposefully created this category, so that you can see your interest expenses separately (mortgage, interest on credit cards, etc.). You may have $2k/m in living costs, and yet pay another $2k/m just in interest. After seeing those items separately, you will be very conscious of your debts.
Here is the most beautiful part of using this spreadsheet compared to simple personal finance apps. You can project your earnings, spending, and net worth into the future. This means that you can play around with the numbers and see what happens. How much money can you save in interest by paying $300/m more towards your credit card? How much more can you make if you invest your money by spending less on the nights out?
Businesses call these projections Pro Forma Statements.
Once you see how small decisions affect your overall wealth, you will change your belief system and financial habits for the better.
Balance Sheet is the document that reflects what you own (assets), what you owe (liabilities), and the difference (your net worth).
Your Net Worth = Your Assets - Your Liabilities
It’s that simple!
Our spreadsheet is further divided into two subcategories: current and non-current assets /liabilities. Current means that an asset (such as money your friend borrowed from you) is to be paid within a year. Non-current assets such as your house imply that the asset is not expected to be converted into cash this year. It’s useful to know how much cash you can pull out during an emergency.
Your net worth is assets minus liabilities plus cash left at the end of each month.
If you earn $8k after-tax income and spend $5k, you have $3k left (as retained earnings) to do whatever you want with.
After considering the financial situation from the example case in the template spreadsheet, it appears that we have $25k in credit card debt at 21% APR. We are currently paying ~$438/m just on interest, so our priority is to pay off that liability first.
I’ve added a row called Investment Rate, which is not something you see in a typical balance sheet. I’ve customized the spreadsheet to our unique situation. You should also tailor your spreadsheet to your situation. The investment rate is the proportion of retained earnings ($3k) that I will put towards my top priority (credit card debt). The remainder will convert into cash, in my scenario. But you could invest it into stocks or pay off the mortgage if you’d like. It’s completely up to you!
Financial literacy is a rare habit. Even celebrities go bankrupt having made hundreds of millions of dollars.
If you were to walk away with just one thing, it shall be the wealth equation: make more than you spend - invest the difference - avoid debt.
Treat yourself as a business by watching your numbers closely. Businesses are optimized to be profitable and grow. Use the same principles and systems as they do.
Use the personal financial statement spreadsheet 1) to understand your financial situation, 2) to adjust your spending / earning habits, and 3) to plan for the future.
Finally, you do not need to have a business degree or to be numbers savvy to master personal finance. You don’t need to invest hundreds of hours a year to learn about and manage your finances. A couple of hours a month is all it takes.
I will leave you with my favorite resources for further research.
Understand Accounting & Financial Terms / Principles