How is managing money in your household similar to managing your finances in a company? Are there personal finance lessons you can learn and strategies you can apply from the business world?
Investmentyogi tells you how to think like a CFO (chief financial officer) and manage your money professionally.
A company exists to earn revenues by selling products or services, managing expenses and earning profits. The goal of any company is to have more revenue and less expenses thereby maximising profits. Most companies of the world have this objective at the very core. Every other strategy revolves around this.
A CFO's role is to:
- Be responsible for company's financial situation
- Make investments for the company taking into consideration risk and liquidity
- Borrow money at the best possible rate
- Maintain a healthy debt/equity ratio
- Monitor and control cost, expenses
- Forecast and prepar the company for financial contingencies
What if you look at yourself as a company and try to assign a CFO's role to yourself? Do you see the similarities here? You will be doing pretty much the same things with your personal finances.
Revenue
A company earns revenue by doing its business which can be selling a product or some kind of service. You also earn revenue by offering your services to someone else. You are being paid for that every month. This is your top line. Just like a business your aim is also to increase your revenue either by switching jobs or getting a promotion.
Other income
Companies sometimes make money from secondary sources for example their investments into government bonds, other companies etc. The same is true with an individual. You also have other sources of income like giving out your home on rent, investments in mutual funds, stocks or sale of property.
Fixed cost
A business has certain fixed cost like machinery, office rental, debt repayment etc. You also have monthly fixed costs like home rent, EMIs, school fees for your children. You always need money to make these payments.
Variable cost
Businesses have variable costs which vary from one month to another. For example salaries paid, raw material used, electricity consumption etc. You have monthly variable costs like groceries, transportation, entertainment, dining out. The figure will vary from one month to another.
Taxes
You have to pay taxes on your revenue (income tax) just as companies pay taxes on their profits. You try hard to minimise your tax liability and so does a CFO.
Interest
If a company has taken loan from a bank of other financial institution for factory, machinery or any other operations then a part of its revenue goes into paying back this debt just as you have to pay EMIs for taking home loan, car loan.
Your capital structure (debt/equity ratio)
Every company needs money for its operations and for that it takes equity capital from investors (either private investors or stock market) and takes debt (in the form of loans from banks and other institutions). The CFO decides how to borrow and how much. The debt to equity ratio is crucial as it impacts the future of the business. Moreover the right structure is different for different kind of businesses.
If you look at your personal money as portfolio, a lot of similarities can be seen. You have a strike a balance between how you invest in debt instruments (like FD, PPF, bonds, NSC etc) and equity like stocks and mutual funds. It will depend upon your income, savings, age, risk profile and future goals. If you think like a CFO it will be so much easier to accomplish this task. You will have to ascertain the right capital structure for yourself. The difference is that companies borrow money using a combination of debt and equity whereas individuals need to invest.
Your profit and loss statement
Prepare your own P&L statement just as the CFO of an organisation does. Here's how:
Total Income = Revenue + Income from other sources
Total Expenditure = Fixed cost + Variable cost + Taxes + Interest
Savings (Profit) = Total Income - Total Expenditure
See if you are a profit-making entity or a loss-making one. Calculate your profit margin like this:
Profit Margin = (Savings/Total Income) x 100
Ask yourself this question: are my savings enough to achieve my financial goals? Am I on track? If the answer is yes then good for you otherwise you will have to improve profit margin or savings which can be done either by increasing the net income or decreasing the total expenditure. Secondly, you will have to think of making investments which will have a balance of risk vs return, depending on your particular situation
A financial plan helps you look at your finances from a strategic perspective and transforms you into your own CFO. Take control of your finances today!
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