What is a Financial Statement?

A financial statement is very important when discussing your financial well-being.  But not many people really understand what a financial statement means or does.  A simple definition would be that it is a snap shot into one’s financial situation.  This snap shot summarizes one’s income, expenses, assets and liabilities.  It essentially shows what kind of cashflow someone has (income – expenses = cashflow), and it also shows what kind of net worth the person has (assets – liabilities = net worth).  In this blog we will take a look at the four different sections of the financial statement which are income, expenses, assets and liabilities.

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Income may come in many different ways.  It can come in the form of a salary, cashflow from rental properties, dividends from stocks and interest from savings accounts.  Basically anything bringing money into your pocket.  Some may only have one source of income and some may have multiple sources of income.  What is common in today’s world is that most people have only one source of income, and that is in the form of a salary.  They may be getting a little in return from interest on savings accounts (that is, if they are saving on a consistent basis).  And as for rental property cashflow and stock dividends, most people have none.  But the idea here is to change your mindset to grow (or change) your income to show more income coming from assets such as rental properties and stocks in the form of rents and dividends.  This will decrease your need of a salary through time with one day attaining the goal of living off assets instead of a salary (financial freedom).  Remember that building wealth is not having a large salary.  Wealth comes from acquiring assets such as real estate.  The more assets you can acquire the more wealthier you become and the more cashflow you can generate from those assets and not be dependent on a job or a salary to live on.  So looking at someone’s income section of their financial statement, you can quickly learn where someone is generating their income from.

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The expenses are pretty straight forward, but probably the most important section of a financial statement.  It depicts what you are spending your income on.  Your home expenses can be in the form of your mortgage, taxes, insurance, electricity, phone, cable, internet and maintenance.  Your personal and family expenses can be in the form of groceries and personal shopping (clothes for example), cell phones, car(s), car insurance and maintenance, restaurants, weekend trips and vacations, etc.  Personal and family expenses is what you spend your money on once you have paid your home expenses.  This is the spending that gets most people into financial trouble.  This is the spending in which liabilities are purchased and bad debt is acquired.  This is the spending that someone absolutely needs to have complete control over if they want to change their mindset.  Home expenses is another reason for some people’s troubles, because you can purchase a home that is simply too expensive and cannot afford.  But once this happens, and you also have bad spending habits in personal and family expenses, this is the perfect mix of getting into major financial trouble.  Many people today are in this situation unfortunately as they have to keep up with everyone else.  They are more inclined to do the wrong thing financially to keep up with the pack (to look good), than to do what they can afford and build their situation to a point in which they can strive.  And this is all part of the mindset I have been writing about since the start of The Freedom Spinner.  I cannot stress it enough, and I will say it again: It is not how much you make, it is how you spend it.  What people make is absolutely useless versus how people spend it.  Remember that making a large salary, in most cases, blinds the person into thinking they are wealthy.  In turn they purchase many toys such as expensive cars and homes and live lavish lifestyles.  What they do not think about is that their large salary is not secured because if they stop working for any reason the money stops coming in.  When the money stops coming in, they will have a much harder time sustaining their expensive cars and homes and lavish lifestyles.  So again, the most important thing someone can do is acquire assets.  These assets will in turn create income in the form of cashflow which will be used to pay your expenses and lifestyle, regardless of the existence of a job.

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Assets are the foundation of someone’s wealth and so another important section of the financial statement.  It shows what a person has acquired that puts money into their pockets.  Assets create income in the form of cashflow and they also create wealth in the form of equity.  Remember that assets put money into your pocket, so these come in the form of investments such as real estate and stocks.  Rental properties put money into your pockets in the form of rents and stocks put money into your pockets in the form of dividends.  I will stress, again, that your job is NOT an asset.  It is simply an income producing vehicle that is only sustainable if you keep on working.  A true asset is an income producing vehicle that is able to sustain itself whether you work or not.  Your goal for financial freedom is not working hard to get that promotion and large salary, it is working to acquire assets that will generate enough cashflow in which you can live off of whether you work or not.  It is acquiring assets that will be able to sustain themselves and create equity so you can buy more assets.  This is a term called using other people’s money to create wealth and acquire assets, because using equity from your rental property to buy another property is using other people’s money as these other people are your tenants who pay you to live in your apartments.  This rent pays your mortgage and property expenses and all you need to do is manage the revenues and expenses of this property.  You are not putting any of your own money into it and you are gaining all the benefits in terms of cashflow and equity.  You take that equity and buy other properties and the same thing happens, the tenants from the new property pay you rent which you take and pay all the property expenses with.  This is the most beautiful and amazing part of acquiring real estate.  You can grow YOUR number of rental properties, YOUR cashflow and YOUR equity, literally using other people’s money and none of your own.

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Now let us talk about the liabilities section of the financial statement.  Liabilities, like expenses, are a very important part of your financial structure.  Since liabilities take money out of your pocket, they have a direct connection to your expenses.  Remember about the importance of how you spend your money, and liabilities are no different as they turn into your expenses.  There are many forms of liabilities, small and large, from simple things such as needing to have the latest smartphones and televisions to larger things such as your personal home and car.  Now, I am not saying do not get a smartphone or television.  All I am saying is that you need to watch what you purchase and how you purchase it.  Using credit to purchase these items and then not paying the debt on your next credit card bill or not paying off your credit line is building up bad debt.  Instead of reducing bad debt (liabilities) and increasing good debt (assets), you are doing the opposite which is financially unhealthy.  But then you say, “Yes I understand, but I cannot pay a $4,000.00 television all in one shot”.  My answer would then be that it is most likely because you cannot afford it so do not buy it.  There are many other televisions within your price range in which you can afford.  But the problem in today’s world is that everyone wants that most recent model.  And that is simply because they need to keep up with everyone else.  Think about it, do you REALLY need that $4,000.00 television?  And if you want to buy that particular television, then save the money until you can buy it without adding bad debt to your financial situation.  The last thing you want to do, is pay a television in small monthly payments for the next couple of years.  And that goes for absolutely anything out there.  Now for the larger liabilities.  I hope I do not have to explain it all again (as I hope you have been reading previous blogs).  I will keep it simple, and if you want more detail, please read my blog on the subject (https://thefreedomspinner.com/2017/02/07/if-my-house-is-not-an-asset-what-is/).  Simply put, your personal home is NOT an asset as it takes money out of your pocket every month and does not generate any cashflow for you.  Therefore your personal home is considered a liability.  As for your car, absolutely nothing but a liability as it simply costs you money on every turn, such as gas and maintenance to insurance and so on.

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So remember, the assets and income sections of the financial statement are connected.  The more assets you can acquire the more income in the form of cashflow you will generate (good debt).  And the liabilities and expense sections of the financial statement are connected.  The more liabilities you acquire the more expenses you will have (bad debt).  The idea is to increase your assets and decrease your liabilities so that your income increases and your expenses decrease.

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Think of the financial statement as a pyramid divided into four different horizontal sections from bottom to top.  The assets form the bottom section, which is the largest section of the pyramid.  The next section of the pyramid going upwards would then be the income.  Then would come the expenses and the top of the pyramid are the liabilities.  This financial pyramid is exactly how you need to set up your financial situation.  Acquiring assets will create income in the form of cashflow.  The more assets you have the more income you generate.  They are directly connected.  Going up the pyramid to the next section, you then need to ensure you control your expenses to be less than your income.  Simply put, you need to live within your means or within the income you generate.  Living above your means is basically reversing the income and expense sections of the pyramid, giving you more expenses than your income.  This will eventually turn ugly in which you begin to have financial problems.  If you would like to spend more, increase your income.  If you want to increase your income, acquire more assets.  The last section of the pyramid are liabilities.  And this we now know, you need to control to have very little of, as liabilities and expenses are directly connected.

When you look at the financial pyramid, how is your financial situation?  Is your financial pyramid firmly supported on its asset base making the pyramid unable to be toppled over?  Or is your financial pyramid upside down, teetering on the point of the assets section, making it so weak it can topple over at anytime (and it will topple over eventually)?

I hope you now understand the importance of a financial statement.  It gives you a snap shot into your financial well-being.  Following your financial statement on a regular basis and making adjustments as necessary is very important in ensuring your financial well being.

The Freedom Spinner

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