Conducting a financial self-assessment
Understanding your finances
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The thought of analysing your finances can be daunting and appear complicated. Don’t be fearful. As with many other areas of our lives it is best to keep matters simple and focus on what you would like the outcome to be. In this scenario, it is simply to understand your financial performance and position:
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Performance: understand how much money you have left over at the end of each month and why that is the case
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Position: understand your financial worth, if everything you owned and owed was valued today
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These will form the basis of any decisions you make going forwards, similar to the approach businesses take when assessing their profitability and financial strength. In order to do this you will need to understand a few key financial concepts:
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Income: money that you receive, such as your salary, investments, property rental or business profits
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Expense: money that you pay to others for goods or services, such as mortgage payments, insurance, utility bills, travel and shopping
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Asset: an item with a monetary value that you own or control, such as a property, vehicle, investments, savings, jewellery or artwork
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Liability: money that you owe, such as a mortgage, vehicle loan or borrowing of any form
List your income sources, expenses, assets and liabilities as four separate lists, together with their corresponding £ values. For example, if you are employed and receive £1,500 after tax each month, list that down as “Salary - £1,000” under your income list. It can be easier to do this on a spreadsheet on a computer, but there is no right or wrong way and a paper and pen works just as well.
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If you are finding this difficult or the explanation unclear, feel free to use the template we have created to help you. Help can also be found at StepChange via their helpline or the anonymous advice tool Debt Remedy to help understand what your spending looks like monthly.
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Using the concepts above you can calculate your financial performance and position:
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Financial performance = Income – Expenses
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Financial position = Assets – Liabilities
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How do I use this information?
Remember the purpose of this exercise – to firstly understand if you are making or losing money each month and secondly, if in the unfortunate event you were repossessed, what other assets you have at your disposal to make up any debt shortfall. In summary, the purpose is to be in full control of your money.
Financial performance: you have calculated your performance to understand your spending habits and ultimately whether you have money left over (a “buffer” or a safety net) each month. In the context of repossession risk, you can now see how much of a buffer you have to service any mortgage debt you currently have and if it increases any further.
If your income is greater than your expenses, you are in a net income position each month. This is good news. The higher this positive value, the better your position.
Conversely, if your expenses are greater than your income, you are in a net loss position each month. This is a sign that you are living beyond your means and is a cause for concern, as it means you are likely becoming increasingly indebted each month. Ultimately if you have limited or no headroom at all each month, this is a sign that you need to reduce your expenses or increase your income to increase your financial flexibility.
Financial position: this is a sign of your financial stability.
If your assets are greater than your liabilities, you are in a net asset position today. This means that the value of your assets is higher than your debts. If you were facing financial difficulty and had to sell every item you owned to paid off all of your debts, you would still have money (assets) left over. This is a good position to be in and a sign you are financially stable. The higher your net asset value, the more stable you are.
If your liabilities are greater than your assets, you are in a net liabilities position today. If you were facing financial difficulty and had to sell every item you owned to paid off all of your debts, you would still have debt remaining. Whist this is not a financially stable position to be in and not recommended, you could still survive financially if your financial performance shows you are in a net income position each month. However, if you are in a net loss position you will find that your net liabilities position will continue to grow each day, week and month. This is unsustainable as eventually you will not be in a position to borrow more money, because lenders will consider you too high risk as you will not have the income to pay them back. If you do not pay your debts, such as your mortgage payments, then there is a very high risk that your home will be repossessed. The same applies to any other assets you own, ultimately leading to bankruptcy.
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Next steps
If you are in a net income position each month, you can still improve financial position further. With your remaining monthly income you could do one of two things:
1. Buy more assets – owning more items that either have monetary value that will increase over time (such as gold and jewellery) or items that will generate more income for you (such as stocks, shares or rental property) will strengthen your financial position and ability to survive financial shocks.
2. Pay off your liabilities – reduce your risk by reducing your debts. The less money you owe someone else, the less vulnerable you are to interest rates increasing or not being able to pay that debt. For example, paying off a chunk of your mortgage with your spare cash will reduce your mortgage payments each month, because you will now be paying interest on a smaller amount of debt.
If you are in a net loss position each month, therefore having to borrow more or using your savings to survive, the solution is straightforward: take control of your finances. Either increase your regular income, which is typically the more difficult option, or simply reduce your expenses. Thankfully there are a multitude of ways that you can do this - we have set out a complete list in money saving tips section to help you.
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