For those of you that have been keeping up with my posts, this one is most likely going to be one of the longer ones I write. But it’s also what I’d consider to be cornerstone content for The Ate Truths.
Have you ever heard the saying “knowledge is power”? Of course you have! You may know how many Instagram followers you have, but do you know your credit score? Understanding the basic financial metrics in this post can help you get a much clearer picture of where you stand. Armed with this information, you can begin to make the changes necessary to right the ship if you have that sinking feeling in your stomach.
A friend of mine reached out to me last week, saying she felt completely out of control when it came to her family’s financial situation. She had so much on her mind that she didn’t even know where to begin to start the process of analyzing the numbers. As I thought more about how to best walk her through everything, I decided it might be a good post idea in case other readers are in the same situation. Below are the same concepts, and in the same order, that I walked her through.
If you have been prone to avoiding the exercise of taking a close, objective look at your finances (as my friend had), the time to stop procrastinating is now! I realize that ignorance is bliss, but that bliss comes at a price, and that price is only going to go up the longer you wait.
If you do take the time to work through all of this (and my sincere hope is that you do it sooner than later), you must be brutally honest with yourself. The thing about data is that we can manipulate it to tell us whatever story we want to hear. Do yourself a favor and uncover every stone, and let all of the financial skeletons out of the closet.
By taking these first steps, you’re way ahead of most people, and I commend you for that; you’ll be glad you did!
Do you spend LESS than you earn each month (positive cash flow), or do you spend MORE than you earn each month (negative cash flow)? Yes, credit cards make it possible, and easy, to spend more than you earn! If you haven’t yet read my post from last week, go back and take a look at some of the statistics regarding credit card debt in our country.
Don’t know if your cash flow is positive or negative? That’s okay, too; that’s why you’re taking the bull by the horns and going through this exercise.
Since we’re still in January, now is a great time to evaluate your spending in 2017. A year’s worth of data is robust enough to give you a relatively holistic picture of how you’re doing. I’ve listed below the steps to do this most easily.
- For your checking account, and any credit cards you have, log in to each account and run a report that shows all account activity in 2017.
- Import your data into Excel so that you can sort it.
- For your expenses, sort the data by description to get a better idea of where you spent your money. How much money did you spend with each vendor, or in each category of expense (e.g., groceries, clothes, utilities, restaurants, etc.)? Do you see any trends?
- Once you’ve compiled your expenditures in both checking and credit cards, go back to your checking account to total up the amount of money you earned during the year.
- With your total earnings and total expenses in front of you, subtract the money you spent from the money you earned. Was your cash flow positive (you spent less than you earned), or was it negative (you spent more than you earned)?
- If your cash flow is positive, congratulations – keep it up! This is the golden rule of personal finance (live below your means). Do this year after year, and you are well on the way to personal freedom and financial independence.
- If, however, your cash flow is negative…ruh roh. Now is the time to act! Begin by scrutinizing all of your expenses, and determine where it might make sense for you to cut back.
- Don’t like the idea of cutting back anywhere? No judgment here, but it may be time for you to consider a side hustle to earn enough money to get your earnings higher than your expenses.
INTEREST RATE ON YOUR CREDIT CARD(S)
If your cash flow is negative, then I have a fairly strong suspicion that credit cards may be part of the problem for you. Review your next credit card statement to see just how much interest you’re paying the credit card companies each month. Wouldn’t it be nice to be earning interest for yourself on savings and investments, instead of handing that money over to those companies?
Could you potentially consolidate your balances onto a 0% interest card to help you start to chip away at that debt?
And guess which number has a HUGE impact on the interest you pay on borrowed money – whether it be credit cards, your mortgage, car loans, or a school loan? It’s…
YOUR CREDIT SCORE
Your credit score is what potential lenders review to determine your credit worthiness, or the potential that you might default on a loan. The higher the credit score, the more likely (theoretically) that you’ll be able to repay the loan, and vice versa. Having a high credit score also means that you’ll generally be offered more favorable (lower) interest rates on the money you borrow. To show you what I mean, I’ve included a picture I took of the terms sheet in a credit card offer I received just yesterday.
Credit scores are divided into the following ranges:
- Poor: 300 to mid-600s
- Fair to good: mid-600s to mid-700s
- Very good to excellent: mid-700s and higher
Your credit score is calculated using the following metrics:
- 35% is based on payment history
- Simply put, do you pay your bills on time?
- 30% is based on the amount you owe
- What percentage of available credit are you utilizing? If your credit cards are maxed out, you will be dinged on this item. The smaller balance you carry against your credit limit, the better.
- What is the total amount of money you owe (credit cards, mortgage, car loans, school loans)?
- 15% is based on the length of your credit history
- How long have you had your various lines of credit open?
- Even if you pay off a credit card, it might make sense to leave the card open (assuming you aren’t paying an annual fee), as this will help your credit utilization (see previous bullet).
- 10% is based on any new credit you’ve applied for recently
- 10% is based on the type of credit you are using
- High credit card or retail store card balances will hurt you on this item
If you don’t know your credit score, the easiest thing to do is download the Credit Karma app on your phone. You can view your score whenever you want (doing this will not hurt your credit score), and the app will even give you recommendations for ways to improve your score.
Much like cash flow, you want this number to be positive. If it’s not, it means you owe more money than you have. To calculate your net worth, subtract your liabilities (what you owe – mortgage, credit card debt, car loans, school loans, etc.) from your assets (what you own – value of home, savings, investments, etc.).
Reducing spending will improve your cash flow, which will help your net worth grow over time!
Now that you’ve got a handle on where your money is going, it may be helpful to have a framework that guides your spending going forward so that you are better able to keep your expenses in check.
A very popular budget is the 50/20/30 budget. These percentages are maximums per category, and are based on your take-home pay, not gross income. The numbers break down this way:
- 50% of income is for living essentials (rent/mortgage, groceries, utilities, transportation, minimum debt payments)
- 20% of income is for financial goals (savings, investments, additional debt payments)
- 30% of income is for personal expenses (movies, clothes, travel, dining out, etc.)
The beauty of this budget is that it allows for easy classification of your expenses, and it does allow for a little bit of flexibility if needed while you get yourself on the right track. Doing a good job of separating wants from needs, and limiting the personal expenses, means you’ll have more money to put toward the financial goals section of your budget!
The better you do with that, the sooner you’ll reach your personal freedom goals!
I’ve included a very basic Excel template that you can use for this budget.
To recap – take some time to sit down and figure out the answer to each of the items in bold. If needed, get your spending under control and start paying down that debt.
Lastly, if you need help working through any of these metrics, shoot me an email; I’d be happy to help you walk through it. It’s worked for me and my family, and I know it can for you too!