Becoming the CFO of your life: Personal Finance basics - Understanding your income statement (Part 1)

High performers are actually doing a great job of being the CEO of their lives. However, their personal finances could need some help and hence they need to be better CFO's (Chief Financial Officer) of their lives. Let us build a comprehensive understanding of our income statement for us improve your finances. We can look at some simple concepts in your income statement which will help us becoming super effective in managing our personal finances and be an awesome CFO for yourself.

We start off with correcting the basics issues impacting our financial lives by looking at out income statements. We look at the three key parts of our income statement which are

1. Top line
2. Bottom line
3. Expenses  

Top line

• Top line for a company means the sales, revenue or turnover for a company
• For you your top line is the money which comes in your bank
• Most of us confuse our top line with salary - gross salary, CTC etc. etc.
• When looking at our top line we must also include earnings from other sources, for e.g. interest income from money in bank or fixed deposits etc.   
• Because we keep our gross salary and CTC in our mind we keep spending based on our gross salary and CTC.
• Unfortunately, we can only spend the money which comes to our bank
• So, let us not confuse our Top line with our CTC
• The Top line for a typical salary earner is
• Top line = CTC - non-cash components - deductions - taxes + other sources of income
• Looking at the formula its quite clear that your Top Line is significantly lower than your
• CTC

Bottom Line

• Bottom line for a company means the profits of the company
• A company which has a bigger bottom line is a better/ stronger company
• For you your bottom line is your profit
• Your profit is the money which is left at the end after a month of earning and spending
• Bottom line is the amount of money you save
• Bottom Line = Savings = Top line - Expenses

Expenses

• Since arriving at your bottom line includes looking at our expenses
• A company which keeps expenses low is considered to be a good company.
• However, for individuals the more we spend (or larger our expenses) the world sees us as more successful
• Wearing expensive clothes, having a fancy car, going for a foreign vacation will make you look successful even though it screws up your bottom line and makes us financially weaker.
• The question to consider is - Are we living for our personal success or our we living to look successful in the eyes of others while harming our personal finances
• Let us look at expenses. The word expenses are self-explanatory
• However, we look at the companies and find there a multiple type of expenses and how they correlate to personal finances

 Cost of living

• For a company this is the Cost of goods sold. It is cost which goes in making a product. If you don’t incur these costs you will be unable to make the product.
• For you this is the cost of living. It is the costs you must incur to earn your salary
• For e.g. you need food, water, health, shelter etc. to have the energy and ability to go and work
• One should not compromise on food, water and health
• However, shelter or home expenses in the form of rent, EMI on home loans or house maintenance expenses is generally a large expense and should be managed well

 

Overheads

• Overheads are non-essential expenses
• For e.g. food is an essential cost and part of cost of living. However, if you are eating out for entertainment then its an overhead
• Generally, a large part of the overheads are the expenses we undertake to look successful in the eyes of society
• These are the easiest expenses to reduce, because they are non-essential expenses
• These are the difficult expenses to reduce, because they are incurred to look successful in the eyes of society
• Remember the expensive clothes, the fancy car, the foreign vacation

Financial expenses

• Financial expenses are the EMI's or the interest you pay to banks and lenders for the loans you have taken
• The worst thing you can do is to incur financial expenses to incur overhead expenses
• Buying expensive clothes, a fancy car or going on a foreign vacation by taking loans is a like committing financial suicide

 Income Statement

• A comprehensive view of our bottom line is our Income statements
• Income Statement = Bottom line = Savings = Top line - Expenses
• Complicating it further
• Income Statement = Bottom line = Savings = (CTC - non-cash components - deductions - taxes + other sources of income) - (Cost of living + Overheads + Financial expenses)

Strategies for improving you improving your income statement

• Increase your top line
• Increase CTC
• Save taxes
• Build other sources of income
• Reduce expenses
• Cost of living = Re-look at it but don’t kill yourself over reducing your cost of expenses
• Overheads = Reduce overhead expenses as much as possible
• Financial expenses = Don’t take loans or be very responsible in taking loans

This has been an intense piece writing and helping you get a better grip on your income. So, will take a break and follow it up with a piece on financial ratios. Financial ratios are a summarize the income statement and gives you a tool to assess your financial strength from your income statement 

Read on the second part of this series
Becoming the CFO of your life: Personal Finance basics – Income Statement Analysis (Part 2)