When we are trying to understand Personal Finance, the best thing to do is to understand what Personal Finance is NOT.
Many people think that accounting and personal finance are the same, but Personal Finance is NOT Accounting.
On the surface they may seem the same; they both have something to do with money. However, the definitions will help us better understand the differences.
Merriam-Webster’s definition of accounting is “the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results.”
Based on this definition, we see that accounting is the process of analysing and recording what you have already done with your money.
This is why having an accountant is usually not enough when it comes to your personal finances.
Accountants generally don’t concern themselves with personal finance (there are some exceptions to this rule). Unless your accountant is also a financial advisor or coach, he or she will likely just look at what you have done with your money at the end of the year and provide you with a report of their analysis.
This report is usually your tax return; what you owe the government or what the government owes you.
Very rarely does the accountant provide an individual with a Balance Sheet or Income Statement or a Net worth statement; all very helpful tools that are necessary to effectively manage your personal finances.
Personal Finance is looking at your finances from a more pro-active and goal oriented perspective. This is what provides the accountants with something to record, verify and analyze.
The Merriam-Webster’s (Concise Encyclopedia) definition of “Finance” is the “process of raising funds or capital for any kind of expenditure. Consumers, business firms, and governments often do not have the funds they need to make purchases or conduct their operations, while savers and investors have funds that could earn interest or dividends if put to productive use. Finance is the process of channeling funds from savers to users in the form of credit, loans, or invested capital through agencies including COMMERCIAL BANKS, SAVINGS AND LOAN ASSOCIATIONS, and such nonbank organizations as CREDIT UNIONS and investment companies. Finance can be divided into three broad areas: BUSINESS FINANCE, PERSONAL FINANCE, and public finance. All three involve generating budgets and managing funds for the optimum results”.
Personal Finance Simplified
By understanding the definition of “finance” we can break our “personal finance” down into 3 simple activities:-
1. The process of raising funds or capital for any kind of expenditure = Generating an Income.
A Business gets money through the sale of their products and services. This is labeled “revenue” or “income”. Some businesses will also invest a portion of their revenue to generate more income (interest income).
A Person gets money through a job, or a small business (self employment, sole proprietorship, network marketing or other small business venture). The money coming in can be a salary, hourly wage, or commission, and is also referred to as income.
A Government gets money through taxes that we pay. This is one of the main ways that the government generates an income that is then used to build infrastructure like roads, bridges, schools, hospitals etc for our cities.
2. Using our money to make purchases = Spending Money.
How much we spend relative to how much we make is what makes the difference between having optimum results in our personal finances. Making good spending decisions is critical to achieving financial wealth – regardless of how much you make.
3. Getting optimum results = Keeping as much of our money as possible
It’s not how much you MAKE that matters – its how much you KEEP that really matters when it comes to your personal finances.
This is the part of personal finance that virtually everyone finds the most challenging.
Often people who make large incomes (six figures or more) also tend to spend just as much (or more) which means they put themselves in debt and that debt starts to accrue interest. Before long that debt can start to grow exponentially and can destroy any hope they would have had to achieving wealth.