Prudent Fiscal Planning (Part 2): Income’s importance in Fiscal Planning and its Effect on Our Standard of Living
In the first post of the series, I discussed the need for prudent fiscal planning in these difficult economic times. Although it may seem that the economy has turned the corner from the most recent, yet severe economic downturn (recession), there are many storm clouds looming on the global economic horizon that could have a knock off effect on the economic citizens here in the states as well as world wide. The best time to embark on a prudent fiscal planning journey is not when all is falling apart, but instead when things are going relatively well, and your mind is stable and calm. Finance, whether it be a country, corporation or family always can be generically reduced to three basic statements: 1. Profit and lost 2. Balance Sheet 3. Cash Flow. All planning therefore begins and ends with one, or all, of these generic expressions of one’s financial position. Let’s begin our discussion on how to fiscally plan by taking on the Income and Expense statement, or by its other name, profit and loss (P and L) . The P and L is the most common budget that the average person both understands and uses when thinking about financial planning. We take income and subtract expenses and then know if we operate under either a profit or loss for any given fiscal period. If we operate under a loss(expenses are greater then income), we have to take from savings, investments, or borrow to fund the extra expenses for any given period. If we have a profit for the period (income is greater then expenses) then we have a saving for the period. Prudent fiscal planning (the budget) begins with the drafting of a P and L, which is revised on a regular basis, once actual economic peformance is compared to our budget to see if we met our expectaions when it comes to both income and expense. Let’s finish this post with a brief discussion on how to properly plan regarding the income side of the P and L.
First, we must define all sources of income today and forecast the sources of possible income and amounts into the the future. I always suggest that clients look at three time periods when contemplating future income: Short (less than a year), intermediate (one to three years), and long term (four years or longer). Of course those periods can be less or more, but as a rule in forecasting(budgeting) the longer the time horizon, the less accurate. Forecasting is like looking into a crystal ball, and few of us have crystal balls. Forecasting is about asking questions and wondering about outcomes and how these possible outcomes might be handled. When forecasting income, we are contemplating sources of income going forward and how they will help us maintain or improve our standard of living. One can use debt to help evolve ones standard of living, but without income sources, now, or in the future to pay for that (assets) which debt helped acquire, debt can lead one to financial ruin, and this is why income is king. One last point regarding income, there are many more sources of income besides our job and all those potential sources should be contemplated, when drafting a budget (fiscal plan). Incomes opposite on the P and L is expense, and of no less importance where fiscal planning is concerned. Let’s make expense the topic of the next part in this ongoing series regarding prudent fiscal planning.
Art Baird, a former high school teacher-whose academic work is in business and economics-continues to study economic and financial theory, as well as micro and macro economic/finance issues of the day, when not playing his role as one founding partner in Creative Marbles Consultancy. You can contact Art at email@example.com or, read his short biography.
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