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In order to move ahead with your finances, you need to first understand your current financial situation. You need to know what is working for you so you can keep doing it and what is not working for you so you can fix it. In almost all cases, even if something is working, there are probably ways to improve it and make it even better.
When assessing your financial situation, here are some key areas to focus on:
List out the different ways that you are currently making money. This list would include your salary, net income generated from any real estate investments, dividends paid from stocks you may own, and any other sources from which you are earning money.
Once you have listed out your income streams, it is important to understand your liabilities. Make a list of all of your debts such as your car loan, student loans, and credit card balances – be sure to include the balance, interest rates, and monthly payments for each one. Once you have done this, it is time to calculate your monthly debt-to-income ratio by dividing the amount you owe by the amount you make.
For example, if you pay $1,250 a month for rent, $250 for car loan payment, and $500 for the rest of your debts, your monthly debt is $2,000 ($1,250 + $250 + $500 = $2,000). If your gross monthly income is $5,000, then your debt-to-income ratio is 40 percent ($2,000 / $5,000 = 40%).
The lower your monthly debt-to-income ratio, the better.
Ability to Handle the Unexpected
Do you have enough money tucked away in case of an emergency? The rule of thumb is to have enough emergency savings to help cover three to six months worth of expenses.
Having an emergency fund is key to healthy finances because none of us know what tomorrow will bring.
You want to be in a position where you would be able to pay your rent next month if you were to lose your job or pay for a $1,500 car repair bill if your car were to break down.
Your credit score is a number that represents your overall creditworthiness. It is the number that significantly impacts you from a financial perspective. Credit reporting agencies calculate your credit score based on your credit history, how often and how many credit cards you open, how many outstanding loans you have and your repayment history, and several other factors.
The reason why your credit score is so important is because it is the number that many organizations look at before making a decision on you. For example, when you apply for a credit card or some type of loan such as a mortgage or auto financing, the banks and credit card companies review your credit score to determine if you are financially responsible and make a decision on your eligibility. And if you are eligible for the credit card or loan, your actual credit score will further determine your credit line or the interest rate for your loan.
Your net worth is a measure of your overall financial health and shows you where you are financially at this point in time. Essentially, your net worth represents what you truly own and is calculated by subtracting your liabilities from your assets.
Your assets include the money in your bank accounts, the value of your investment accounts, the market value of your home, and the cash value of any insurance policies among other things. Your liabilities are your debts and you should already have a list of those since we were just calculating your monthly debt-to-income ratio earlier.
How Often Should You Assess Your Financial Situation?
I, personally, assess my financial situation once a year as a financial health check and right before I make any big purchases or take on any major investments. You may want to consider doing the same or as you see fit.
It is especially rewarding to perform an assessment of your financial situation a few months after you implemented any money saving tactics or added new income streams as you can see your financial health improving through the steps and measures that you have put in place.
Are you currently assessing your financial situation on a regular basis? If so, how often are you doing it? Leave a comment! I look forward to hearing from you.