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December 2018

The Basics of Accounting and Personal Finance

In today’s financial climate, personal fiscal responsibility is more important than ever. Knowing how much money you have, the liquidity of your assets and being able to successfully manage you assets is essential. However, it seems that these are not skills that our educational institutions place much value upon. While math and science courses are staples and graduation requirements in our high school curricula, arguably more applicable personal finance courses are not. Perhaps that is why many students are feeling increasingly unprepared to make the crucial financial decisions that they face upon graduation. A key aspect of understanding personal finance is comprehending the basics of accounting. Therefore, it is my opinion that at least one basic accounting course should be a requirement for all high school students. Below I will briefly outline several basic concepts that should help give interested readers an overview of accounting.

The most fundamental tenet of accounting is the concept of debits and credits. Every company (or individual) tracks their flow of assets and liabilities through the use of debits and credits. When cash is involved in a transaction, a basic rule of thumb applies. If the amount of cash on hand is increasing, then the cash account is “debited.” Likewise, if the amount of cash on hand is decreasing, the cash account is “credited.” It is that simple. The concept of a “journal entry,” is also essential in understanding the mechanics of debits and credits. Simply put, whenever a transaction takes place, a corresponding journal entry, or written record of the transaction must be completed. Journal entries spell out in prose which account is being debited and which is being credited. To further illustrate this concept, consider the following example:

A business (Company D), purchases 20 tickets to a local sporting event at $10 each for a grand total of $200. Therefore Company D has spent $200 of its cash on hand. Company D’s “Cash” account would be credited for $200. Likewise, one of Company Ds “Expense” accounts would be debited for $200. A corresponding journal entry would be written to notate this. While this example has been greatly simplified, the conceptual aspect is sound.

Keeping track of your personal finances may only require a few entries per month, depending on the number of significant financial transactions you perform. However, businesses are in a much different scenario. Due to the scope of their operations and the sheer number of different accounts they maintain, it is vital they organize their transactions in an easy-to-view format. The format of choice is a “T-account.” A t-account looks just as its name may indicate – a “T.” The name of the account serves as a header while debits occupy the left side of the “T” and credits occupy the right. This allows auditors as well as company accountants to quickly find transactions and follow the flow of money throughout the company. For every account that a company maintains, a corresponding t-account is created.

These t-accounts are then grouped into three major categories; “assets,” “liabilities,” and “stock holders’ equity.” These categories make up a fundamental equation that all accountants must know; ASSETS = LIABILITIES + STOCK HOLDERS’ EQUITY. Accounts that are grouped under the “assets” label include cash, accounts receivable and equipment. Accounts payable, accrued expenses and wages payable are some of the “liability” accounts, while retained earnings and capital stock are the main “equity” accounts.

The final piece of the accounting puzzle for a company is the preparation of financial statements. These statements are made up of every account and calculation that has been previously mentioned. A balance sheet is specifically comprised of the “assets = liabilities + equity” equation. An income statement contains information regarding the revenues and expenses of a company. In short, every financial statement builds on the data contained in the previous one, just like accounts and journal entries are derived from each other. If you are looking for visual examples of these statements, I highly recommend searching for them with “Google Images.” While perhaps an obvious answer, a visual aid is often crucial in truly comprehending a subject.

Personal Finance & Personal Investing Tips

Once you have your personal finance house in order another area of finance, personal investing, looms as a challenge. How do you finance major goals like retirement? Personal investing is the answer, so here are some investing tips to help you avoid disaster.

Get your personal finance foundation on firm ground before rushing into personal investing in a big way. Poor credit and money management can force you into bankruptcy even if you have considerable assets. Scenario: You pay $1,000,000 for a house putting next to nothing down in 2006. The only real money you’ve saved has been in your 401k at work, which is 100% invested in stock funds and company stock. A few years later you lose your job as your employer falls upon bad times, the stock market falls like a rock, and your house is worth $700,000 if you’re lucky. Sound familiar?

If you can’t pay your bills you are technically insolvent. In the above case you go broke and end up with a lousy credit rating at the same time. The truth is that millions of Americans have invested in real estate they couldn’t afford and stocks investments they didn’t understand; and many paid dearly for their financial mistakes. Concentrate on personal finance first: your insurance needs, credit management, and a cash reserve to cover financial emergencies should be your first concern. The truth is that as long as you can stay current on your bills and you have an excellent credit rating, you’re still alive financially. Any weakness in the above personal finance areas makes you vulnerable to financial disaster.

Personal investing is the area of finance that puzzles many people, even some who are well off financially. After all, most folks work for a living and have no financial education, especially in the investment and investing arena. Stocks and bonds are not that difficult to understand, but without any financial education or background, they may as well be a foreign language. The best investment tip I can give an inexperienced or new investor is to start investing with mutual funds. These funds were designed for the investing public. They offer diversification and professional management at a reasonable cost. You can invest large or smaller amounts and have access to your money on any business day.

Now for some mutual fund investing tips. Different funds have different financial objectives, risks, and cost structures. Get your feet wet with the safest funds, money market funds. They pay interest in the form of dividends, their share price does not fluctuate, and the cost of investing is usually low. If you need some or all of your money back there is little chance of taking a loss. Once you have some money accumulated there start small in stock funds if you are younger, and bond funds if you are closer to or in retirement. Bond funds pay higher income in the form of dividends with moderate investment risk, while stock funds feature higher profit potential along with higher risk.

Mutual funds do the investment management for you. Your job is to pick the fund(s) that have the same financial objective(s) you do. The best funds in terms of the cost of investing are called no-load funds. They have no sales charges or commissions, and your total cost to invest can be less than 1% a year. If you’re ready to get into personal investing, look no further than mutual funds… the new investor’s best friend in my opinion.

Effective and Relevant Personal Finance Methods

Personal finance management when utilized correctly can go a very considerable way towards streamlining the financial situation of people, by ensuring that they reduce wastage of their money and also increases their financial status as well. One of the best aspects of personal finance management is that when used in the right manner, you will be able to achieve all of your consumer dreams and so the latest clothes and jewelry can all be yours.

The cornerstone of a secure and happy financial status is careful planning and discipline and if you can manage to devise a personal finance management scheme and stick to it religiously, then you cannot go wrong. Of course, this is only part of the puzzle and there is a number of other issues you will need to achieve for a final result. You need to ensure that a chart of all of your income, with relevant deductions for your expenses is carried out. Separate need from want, and try and scale down the want column where and when possible.

As important as it is that you carefully devise your personal finance management system, it is even more essential that you actually put the ideas into practice and that you actually follow the deadlines and rules you set for yourself. Doing so will make sure you do not lose your focus and worse yet, fall into bad habits.

People are often concerned with using a finance plan as they are worried about the expected cost that one of these will set them back by. In reality, anyone (even you!) can make such a plan, after all, who on this earth is more intimately aware of your financial situation than you? If you are really struggling to get a decent personal finance management system up and running, you can always hire a professional to do the grunt work for you. Just remember, this will cost you money, so be prepared for that.