The difference is personal profit, which, if accumulated as investment, becomes your wealth. The income statement clearly shows the relative size of your income and expenses. If income is greater than expenses, there is a surplus, and that surplus can be used to save or to spend more and create more expenses. If income is less than expenses, then there is a deficit that must be addressed. If the deficit continues, it creates debts—unpaid bills—that must eventually be paid.
Over the long term, a deficit is not a viable scenario. The income statement can be useful for its level of detail too. You can see which of your expenses consumes the greatest portion of your income or which expense has the greatest or least effect on your bottom line. If you want to reduce expenses, you can see which would have the greatest impact or would free up more income if you reduced it.
Financial statement - Wikipedia
If you want to increase income, you can see how much more that would buy you in terms of your expenses Figure 3. Each loan payment actually covers the interest expense and partial repayment of the loan. The interest is an expense representing the cost of borrowing, and thus of having, the car and the education. The repayment of the loan is not an expense, however, but is just giving back something that was borrowed.
In this case, the loan payments break down as follows Figure 3. Figure 3. She can see, for example, that living expenses take the biggest bite out of her income and that rent is the biggest single expense. If she wanted to decrease expenses, finding a place to live with a cheaper rent will make the most impact on her bottom line. Or perhaps it would make more sense to make many small changes rather than one large change, to cut back on several other expenses. She could begin by cutting back on the expense items that she feels are least necessary or that she could most easily live without.
Personal financial statements usually consist of
Perhaps she could do with less entertainment or clothing or travel, for example. Whatever choices she subsequently made would be reflected in her income statement. The value of the income statement is in presenting income and expenses in detail for a particular period of time. The cash flow statement A summary of actual cash flows for a period, detailing the sources and uses of cash and classifying them as from operating, investing, or financing activities.
This differs from the income statement because it may include cash flows that are not from income and expenses.
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Examples of such cash flows would be receiving repayment of money that you loaned, repaying money that you borrowed, or using money in exchanges such as buying or selling an asset. The cash flow statement is important because it can show how well you do at creating liquidity, as well as your net income. Liquidity is nearness to cash, and liquidity has value.
An excess of liquidity can be sold or lent, creating additional income.
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A lack of liquidity must be addressed by buying it or borrowing, creating additional expense. These payments reduce her liquidity, however, making it harder for her to create excess cash. Her cash flow statement looks like this Figure 3. Note: On a cash flow statement, negative and positive numbers indicate direction of flow. A negative number is cash flowing out, and a positive number is cash flowing in. Conventionally, negative numbers are in parentheses. As with the income statement, the cash flow statement is more useful if there are subtotals for the different kinds of cash flows, as defined by their sources and uses.
The cash flows from income and expenses are operating cash flows Recurring cash flows that result from income and expense events. The loan repayments are cash flows from financing Nonrecurring cash flows that result from the borrowing or repayment of debt, or from the issue or repurchase of equity. In this case, cash flows from financing include repayments on the car and the education.
Free cash flow Income remaining after the deduction of living expenses and debt obligations that is available for capital expenditures or investment. It is calculated as cash flow from operations less debt repayments. The most significant difference between the three categories of cash flows—operating, investing, or financing—is whether or not the cash flows may be expected to recur regularly.
Personal Financial Statement
Operating cash flows recur regularly; they are the cash flows that result from income and expenses or consumption and therefore can be expected to occur in every year. Operating cash flows may be different amounts in different periods, but they will happen in every period. Investing and financing cash flows, on the other hand, may or may not recur and often are unusual events. Typically, for example, you would not borrow or lend or buy or sell assets in every year.
This cash flow statement more clearly shows how liquidity is created and where liquidity could be increased. If Alice wanted to create more liquidity, it is obvious that eliminating those loan payments would be a big help: without them, her net cash flow would increase by more than 3, percent. In business or in personal finance, a critical piece in assessing the current situation is the balance sheet.
Unlike the income or cash flow statements, it is not a record of performance over a period of time, but simply a statement of where things stand at a certain moment. The balance sheet is a list of assets, debts or liabilities, and equity or net worth, with their values. In business, assets are resources that can be used to create income, while debt and equity are the capital that financed those assets. Thus, the value of the assets must equal the value of the debt and the equity. It simply must always be true, because if there are assets, they must have been financed somehow—either through debt or equity.
The value of that debt and equity financing must equal or balance the value of the assets it bought. In personal finance, assets are also things that can be sold to create liquidity. Liquidity is needed to satisfy or repay debts.
That is, you should have more to work with to meet your obligations than you owe. Literally, net worth is the share that you own of everything that you have. It is the value of what you have net of less what you owe to others. Whatever asset value is left over after you meet your debt obligations is your own worth.
It is the value of what you have that you can claim free and clear. Your net worth is really your equity or financial ownership in your own life. Here, too, the personal balance sheet must balance, because if. Alice could write a simple balance sheet to see her current financial condition. She has two assets her car and her savings account , and she has two debts her car and student loans Figure 3.
Partnership Financial Statements Example
Negative net worth The mathematical result of liabilities being greater than the value of assets, or debts being larger than the value that can be used to meet them. Since debts are obligations, this would cause some concern. In business, when liabilities are greater than the assets to meet them, the business has negative equity and is literally bankrupt.
In that case, it may go out of business, selling all its assets and giving whatever it can to its creditors Lenders; anyone to whom debt is owed. More usually, the business continues to operate in bankruptcy, if possible, and must still repay its creditors, although perhaps under somewhat easier terms.
Creditors and the laws allow these terms because creditors would rather get paid in full later than get paid less now or not at all. In personal finance, personal bankruptcy An economic situation when the value of debts is greater than the value of the assets that can be used to satisfy them.
Formal bankruptcy is also a legal process aiming to compensate creditors, governed by the laws of the nation or state in which it occurs. But because creditors would rather be paid eventually than never, the bankrupt is usually allowed to continue to earn income in the hopes of repaying the debt later or with easier terms.
Often, the bankrupt is forced to liquidate sell some or all of its assets.
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Because debt is a legal as well as an economic obligation, there are laws governing bankruptcies that differ from state to state in the United States and from country to country. Although debt forgiveness was discussed in the Old Testament, throughout history it was not uncommon for bankrupts in many cultures to be put to death, maimed, enslaved, or imprisoned.
It is not listed on her balance sheet because the value of her education, like the value of any asset, comes from how useful it is, and its usefulness has not happened yet, but will happen over her lifetime.