Preamble: The terminology Household Financial Health Tool is very much self-explanatory. The purpose of this article is to generate set of simple instructions to create a mirror to show the health of your household finances.
Lifestyle and Quality of Life: As a lifestyle we all like to have the best quality of life and believe in the slogan Earn More Spend More. There is nothing wrong with that so long as you know the boundaries. And, this works perfect for the economy as it grows busineses / manufacturing, which in turn increases country’s Gross Domestic Product (GDP).
However, some people stretch it too much and get into the scenario of Earn Whatever Spend More. At some point, we all have been to that mindset and start doing emotional spending. This becomes a lifestyle- whether using high interest bearing credit cards, line of credit, payday loans or any form of temporary borrowings.
Hard Truth: The basic rule is expenses should not be more than income. This is true whether you are running a business or household. It means you should not spend what you don’t have. There are still two exceptions to the rule-buying a house or a vehicle, most likely everyone depends on the loan from the banks. Still we should try to put as much equity as possible.
Boundaries: With the advancement of banking system and financial products, it has been very convenient to access money through credit cards and line of credit for personal use. And with the availability of enormous products of comfort and luxury, it is very difficult to resist the temptations to buy things, then we resort to credit cards and line of credit. Just want to say, you need to set your own boundaries how far you can go in leveraging your finances.
Role of Financial Institutions: Banks and financial institutions have their own set of criteria to assess the credit limit of borrowers. Banks and financial institutions usually follow debt-service ratio or net worth criteria to assess these borrowing / credit limits. Its not difficult to qualify for these credit cards and loans so long as you are having income coming consistent for few months. I am not against holding credit cards, but use them smartly.
Financial Discipline:When it comes to living comfortable life with more financial security and less stress, we need to have some financial discipline. You can learn the easy way by following the steps of financial discipline or the hard way, through your own experience after draining lot of money.
I am here to explain the easy way
There is one famous and efficient tool for assessment of financial health, it is called computation of Net Worth. Net Worth is sum total of all assets minus total liabilities. This is primarily used by banks and financial institutions for businesses.
Adjusted Household Net Assets: Based on my knowledge and experience, I have created a variation of Net Worth computation, let’s call it computation of Adjusted Household Net Assets. When it comes to running household, the criteria should be comfortable living, least stress, enough cash flow for day to day requirements, vacation funds and also rainy day reserves. Rainy day reserves are needed for times when income sources are cut off suddenly due to job termination or for any other reason. Computation of Adjusted Household Net Assets can be for one person if living alone or combined for both partners if living together.
Here is the suggested format for calculation of Adjusted Household Net Assets:
This is the list of items you need to fill out in (A) and (B) and see the result in (C) below:
A) Assets: Amount in your local currency
1 Immovable Property (House / Apartment) at Purchase Value:
2 Vehicles (Market value as per black book / blue book / any website):
3 RRSPs / 401(K) / any other retirement savings:
4 GICs / Term Deposits / any other savings:
5 Shares of Publicly Traded Companies (Market Value as per stock exchange):
6 Jewelry (Gold and Diamond only at market value):
7 Cash Balance in Chequing / Saving account in banks etc.:
TOTAL ASSETS (SUM OF 1 TO 7)
(B) LIABILITIES:
1 Mortgage on Immovable Property (House/Apartment):( Balance outstanding as on date)
2 Vehicle Loan ( Balance outstanding as on date)
3 Line of Credit from Banks / Financial Institutions ( Balance Outstanding as on date)
4 Credit Cards ( Balance Outstanding as on date)
5 Any other loans for personal use ( Balance Outstanding as on date)
TOTAL LIABILITIES (B) ( Sum of 1 to 5 Above)
(C) ADJUSTED HOUSEHOLD NET ASSETS ( A – B) :
This one number is your mirror. If you are in positive, that is Good. If it is negative, you have to decide how much negative you can handle. You need to this exercise every month.
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Given below are the Detailed Notes on all the 12 items above explaining the basis of these items.
A) Assets:
1 Immovable Property (House / Apartment) at Purchase Value:
Note: Usually banks and appraisers use market value of the house for this type of calculation to take into account the increase in value of property. and, then borrowers get to take 2nd mortgage on the house. If this is used for personal spending, its not efficient financial decision.
Purposely for computation of Adjusted Household Net Assets, I have retained the purchase price of the house as the difference between the market value and purchase price is unrealized profit or future profit. For the purpose of running your household, I would not recommend to consider the unrealized profit in the household financial workings. In future, if you flip the house and make some profit, that will be reflected in your cash balances at number 5 or in any other form of assets below.
2 Vehicles (Market value as per black book / blue book / any website):
Note: Personal vehicles should always be included at their market / realizable value. This will remind you that this value is going down over time and you need to build up some cash in your banks for future replacement. And, not only that, ideally you should try to keep the vehicle loan outstanding below the market value of the vehicle.
3 RRSPs / 401(K) / any other retirement savings:
Note: These are the funds sitting in your retirement account. Usually they are not used for running day to day household. However, they can be withdrawn in case of extreme emergencies but they are subject to income tax.
4 GICs / Term Deposits / any other savings:
Note:These GICs or fixed deposits are like rainy day reserves and should be treated accordingly.
5 Shares of Publicly Traded Companies (Market Value as per stock exchange):
Note:These are shares quoted on stock exchanges and values fluctuate according to market conditions. Lots of people trade in these kinds of securities to generate extra income.
6 Jewelry (Gold and Diamond only at market value):
7 Cash Balance in Chequing / Saving account in banks etc.:
Note: This is day to day bank balance and large amounts should not be kept in this accounts, for one, its tempting to spend money as it is readily accessible and second, usually fraudulent transactions through hacking happen most of the time in chequing or savings account. Therefore, extra amount over and above monthly budget should be transferred into GICs or fixed deposits.
TOTAL ASSETS (A) ( Sum of 1 to 7 Above)
(B) LIABILITIES:
1 Mortgage on Immovable Property (House/Apartment):( Balance outstanding as on date)
2 Vehicle Loan ( Balance outstanding as on date)
3 Line of Credit from Banks / Financial Institutions ( Balance Outstanding as on date)
4 Credit Cards ( Balance Outstanding as on date)
5 Any other loans for personal use ( Balance Outstanding as on date)
TOTAL LIABILITIES (B) ( Sum of 1 to 5 Above)
Adjusted Household Net Assets ( A – B) : This one number is the result of all your financial transactions of running the household.
(This computation table / format has been created for personal use only. Use of this table/ format by any entity / organization for commercial or non-commercial purposes will require prior permission from the owner of website panicfreesushi.com)
Adjusted Household Net Assets: For the purpose of clear understanding, if the net balance of Adjusted Household Net Assets is positive, its a Good result and if the net balance is negative, its Not Good. However, the degree of Good or Not Good will depend upon the quantum of positive or negative balance.
Periodicity: The purpose of this computation is not a one time exercise. This tool is relevant only if it is used consistently over the months to see whether your financial situation is improving / constant / adverse. Once you get used to it, this becomes your lifestyle and then it will carry on for years.
This computation can be done on monthly / quarterly / half yearly or annual basis. Ideally, it should be done on the 1st day of every month taking data as on last day of the previous month (like if you are doing computation on 1st day of May 2023, the data should be taken for April 30).
If it is not possible to do it every month, then it could be done on quarterly / half yearly basis and definitely at the year end. As you can see, you need to fill in these 12 numbers in the above format, the resultant figure will tell you where you stand in terms of handling your household finances. This is a simple addition / subtraction of 12 numbers, the person filling these numbers do not need to have a finance background. (I have also created an Excel format where addition / subtraction is automated, please request on the home page if you need one). These all assets and liabilities are part of running your household. There are no business assets or liabilities in this calculation.
Examples: Broadly, there are four possible scenarios when it comes to making month-to-month or year-to-year comparison of computation of Adjusted Household Net Assets. This comparison will provide you a trend showing the direction of your financial situation.
Here are the four scenarios:
Scenario 1 – Good – All The Way
Scenario1.pdf (panicfreesushi.com)
Scenario 2: Heading from Good to Not Good
Scenario2.pdf (panicfreesushi.com)
Scenario 3: Not Good – All The Way
Scenario3.pdf (panicfreesushi.com)
Scenario 4: Heading from Not Good to Good
Scenario4.pdf (panicfreesushi.com)
The purpose of creating these scenarios is to show the financial picture under various situations. The purpose is not to scare anyone but to give you information to determine your risk tolerance and take decision w.r.t. which category you want to be in. This terminology/ format does not exist in this format anywhere to the best of my information.
I have used Canadian dollar as currency for examples given in these Scenarios. You can use your local currency for the purpose of calculation, the interpretation will still be same. The truth is 2+2=4, it does not matter which country you live in or which currency you deal in.
I have this format on an excel spreadsheet as well, please message me on the home page if you need one.