This is the second part of determining “Where Are You Now?” in the financial planning process. Our prior segment covered the Net Worth Statement, and this segment will cover the Income & Expense Statement. These two statements work together to define your current financial situation.

The main thrust of this exercise is to determine your “current lifestyle.” In other words, how much does it cost you each year to live the lifestyle that you are currently living? Incidentally, your “current lifestyle” is a great starting point for determining your “retirement lifestyle,” which is something we’ll cover in the next segment.

A secondary aim of this exercise is to determine how much savings you are generating each year. In certain cases, there might not be any savings at all, and this exercise will help you uncover the extent of any shortfall, so that you can begin eliminating any wasteful spending.

Creating an Income & Expense Statement

Here we go. This time take another piece of paper and draw a line down the center of it.

1. In the left column, write down your sources & the amounts of your annual INCOME.

2. In the right column, write down your annual EXPENSES.

The INCOME column (left-side) should include sources of income such as: salary/bonus, pension, rental income, and other sources of income. (Note: Keep it consistent by listing or estimating your after-tax income. Otherwise, you’ll need to have income & payroll taxes listed as expenses.)

The EXPENSES column (right-side) should at least differentiate between mandatory expenses (e.g., mortgage payment, utilities, etc.) and discretionary expenses (e.g., dining, vacation, etc.). You may need to make adjustments to your expenses if they do not recur on an annual basis as is typically the case with larger expenditures for household projects or vehicle purchases.

This process can be as detailed or rudimentary as you’d like it to be. Some personal financial software programs are especially helpful for categorizing income & expenses when creating an Income & Expense Statement. However, be prepared to invest a considerable amount of time if you choose to go that route.

On the other hand, if you want to quickly arrive at your current lifestyle without going through a detailed analysis of your spending habits, then simply subtract an estimate of your annual savings from your total income. This will provide you with a fairly reasonable estimate of your annual spending.

Analyzing Your Income & Expense Statement

Take a moment to review this statement, and at least ask yourself the following questions:

1. What happens if any of the income disappears for a period of time or altogether? It might necessitate having a larger allocation to emergency savings if you think this could become a reality.

2. Do your life insurance and disability insurance policies meet your needs?

3. Wasteful spending can become an unnecessary drain on your finances. Is there anything that could be trimmed back?

4. What are your goals and priorities? Are your finances oriented toward achieving them?

In summary, take the time to review both the NET WORTH STATEMENT and also the INCOME & EXPENSE STATEMENT together to better understand your current financial situation and to determine if priorities are being properly funded. Hopefully, you’ve found the two exercises to be helpful and enlightening. In our next segment we’ll cover: “Step Two: Where Do You Want to Be in the Future?” In the meantime, please contact Leo if you have questions about engaging the services of a CFP® professional.