Time for your year-end financial review
By Greg
McBride, CFA • Bankrate.com
Over the next few weeks, the business headlines
will be dominated by year-end corporate financial results. But the
preparation of year-end financial reports doesn't have to be an exercise
confined to the corporate sector. Households also can benefit from
a financial review and use this as a framework for 2005. Although
the terminology may be different, the objective is the same.
Company reports often tout growth in the "top
line" and the "bottom line," referring to revenues
and earnings. For households, the starting point is determining
total income, particularly net income, over the past year. Arriving
at total expenses is next. Actually this is even more important
than total income because people have more control over how much
they spend than how much they make. It is most easily accomplished
by using a budget to catalog all expenses throughout the year.
If you didn't have a budget in place in 2004,
establishing one for 2005 is a priority. Getting a handle on your
finances starts with a budget. Only then will you be able to accurately
track spending, trimming expenses where necessary. These sometimes
painful decisions often are what are needed to establish or increase
regular savings.
The bottom line for household finances
is whether net income was greater than household spending. Hopefully
it was. If so, figure out where the extra income went. Was it used
to add to an emergency savings fund, put aside for another financial
goal such as a new home or retirement, or is it still sitting in
a low-yielding checking account? For those who spent more than they
made, was it accumulated savings or taking on additional debt that
made up the shortfall?
Several important financial metrics in the corporate
arena revolve around the amount of long-term debt. A similar evaluation
of the household debt picture is warranted. Look at the current
debt load compared to last year, being sure to include the current
outstanding balances on credit cards, auto loans and any personal
loans. Do you have more or less debt than one year ago? Those that
managed to pay down debt in the past year as interest rates began
to rise are already seeing the debt repayment efforts pay dividends.
But for those that now have a larger debt burden that
isn't a result of buying a larger home, there are some important
considerations. Debt being incurred at variable interest rates --
adjustable-rate mortgages, home equity lines of credit and credit
card debt -- will face a steeper uphill grade of repayment as interest
rates rise. Corporations of varying sizes rushed to issue bonds
at low fixed interest rates in 2004, preferring to lock in their
interest costs at low levels. The same opportunity exists for households,
with fixed mortgage rates remaining below 6 percent and fixed-rate
home equity loans below 7 percent.
Another term thrown around in corporate reports is
"cash flow." In corporate financial statements, cash flow
is used to assess how much cash is actually coming into the business
and how this cash is being utilized. While companies have a host
of noncash expenses that make this necessary, an equally valuable
undertaking for households is to evaluate current savings. Tally
your total savings account withdrawals vs. total deposits, or compare
your savings account balance at the end of 2004 to the beginning
of 2004. If the current balance isn't enough to cover at least three
months of expenses, there is more work to be done. Once a sufficient
savings cushion has been accumulated, shift your focus to saving
for other financial goals, both short- and long-term.
After a recap of the year past, companies often
issue guidance as to revenue and earnings expectations for the coming
year. In a similar fashion, households can set some financial goals
for the next 12 months. People often resolve to make more money
in the new year, but set a goal to save more too. Set up an automatic
payroll deduction to go straight to a savings account or a regularly
scheduled monthly transfer from a checking account to a savings
or money market account. Perhaps through your financial review process,
you'll uncover additional opportunities to increase savings.
Greg McBride is a financial analyst
for Bankrate.com.
For advice regarding your specific
situation, please e-mail one of Bankrate.com's
Q&A experts or visit the Personal
Finance Advice channel on Bankrate.com.
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