Step 1: Financial Capital

The guidance provided in this section presumes you have already read the chapter on Financial Capital in our book, Prosper! How to Prepare for the Future and Create a World Worth Inheriting. If you have not, we strongly recommend doing so first.

Assuming you've started work on the emergency cash savings detailed in Step 0 of this guide, your next steps towards Financial Resiliency start with taking a hard, honest look at your current situation. How much in savings do you have, after subtracting any debts you owe? Are you living within your means when it comes to your monthly income and expenses?

Build Your Personal Financial Statements

In business, financial statements are the primary vehicle for assessing and tracking the health of a company. These documents clearly show whether a company is solvent or not, and whether it operates at a profit or a loss.

There’s no difference when it comes to an individual person or family. You need to have this visibility just as badly. And once you do, it enables you to start identifying what your financial priorities should be.

Specifically, we advise everyone to compile their own personal version of these two essential documents:

  • a Balance Sheet
  • an Income Statement

If you’ve never put one of these together before, don’t worry. It’s pretty straightforward. Mostly, it involves chasing down and bringing together information from such sources as your bank, credit card and brokerage account statements. For even the most-disorganized, this likely won’t take more than 3-5 hours of sleuthing, which can be spread over several days or weeks.

(FYI: In the accompanying What Should I Do? workbook, we have helpful templates and step-by-step guidance that make building these statements easy.)

And for those of you who already have these, or similar, statements already prepared – Kudos! You get to skip to the next section of this chapter.

For those of you remaining, here’s what you need to do now:

Building Your Income Statement

An Income Statement (also referred to as a Profit & Loss Statement) is really just financial-speak for “family budget”. It answers the questions: How much money comes in each month? How much money goes out? And how much money (if any) is left over?

The money you earn each month is your Income. If you work for a company, most if not all of your income arrives in the form of the paycheck(s) you receive. If you have investments, you may also receive forms of passive income, such as dividends on stocks or bond coupon payments:

  • Active income (paycheck)
  • Passive income (dividends, interest, etc)
  • Any other activity that puts new money in your pocket

Simply put, your Expenses are the things you spend money on. They include:

  • Cost of living bills (housing, food, transportation, health care, utilities, etc)
  • Taxes
  • Debt interest/re-payment
  • Any other cost that takes money out of your pocket

If you're comfortable working in Excel, here's a good free template to use to build your personal Income Statement. 

Subtracting your Total Expenses from your Total Income reveals your Monthly Net Profit (or Loss). This is the amount of money you have (or don’t have) to use towards growing your financial capital.

Knowing this amount allows you to begin to address foundational financial questions such as:

  • Can I afford my current lifestyle?
  • How well-positioned am I to build financial wealth? At what rate?
  • Was I aware enough of all the expenses I spend money on?
  • Is there opportunity to reduce any of my expenses?
  • What’s my opportunity for increasing my income?

The visibility this exercise brings into your actual state of household money flows is often eye-opening. Oftentimes, it brings to light areas of overspending you may have been blind to. Which is actually good news, because it enables you to start making intelligent decisions about non-essential expenses you may be able to pare back on – and that becomes ‘found money’ you can start directing to other aspects of life you care more about.

Which brings us to the next exercise:

Building Your Balance Sheet

The Balance Sheet is a snapshot of your Financial Net Worth. This answers the question:  How much money do I have to my name?

Notice the “Net” in Net Worth. That means it represents your wealth after any debts you hold are taken into account (hence, it’s your wealth net of debt).

So, your personal Balance Sheet will include both Assets (the things you own that have value) and Liabilities (debts you owe). The difference between the two is your Financial Net Worth.  See? We told you the math here would be simple.

Now’s the point where you get busy tracking down all of your Assets and Liabilities.

Assets can be any of the following:

  • Cash
  • Stocks
  • Bonds
  • Real Estate holdings
  • Insurance
  • Annuities
  • Business ownership interests
  • Anything else you can sell to somebody

And your Liabilities will include:

  • Credit card debt
  • Mortgage(s)
  • Education loans
  • Taxes due
  • Other loans/liens
  • Any other obligations you have to pay somebody

Again, if you're comfortable working in Excel, here's a good free template to use to build your personal Balance Sheet.

Once you’ve brought all of the data into one place, calculating your Total Assets and Total Liabilities is a cinch. As mentioned, subtracting your Total Liabilities from your Total Assets yields your Financial Net Worth – which is the amount of financial wealth you own “free and clear”.

Obviously, most of us hope this number is positive, and as large as possible. But whatever the number, it is what it is – for the moment, at least.

For those of you wondering how your financial wealth stacks up versus others at your same life stage, this chart will give you a sense (note that as age increases, net worth is most influenced by home/property values):

But whatever net worth number your calculations have arrived at, you’re now armed with accurate data that can start influencing your decisions on what to do next.

While everyone’s financial situation is unique, having this insight allows you to start crafting informed responses to important questions like:

  • Do I have enough net wealth to fund my life’s goals? If not, how much more do I need?
  • Am I too indebted for comfort?
  • Should I prioritize increasing my assets, or paying down my debts?
  • Are my financial assets well-diversified?
  • Are there any assets I’d prefer to sell now versus holding longer?
  • Which debts should I pay off first?

Taking Action

With your personal financial statements in place, you're now armed with the necessary clarity on how well-positioned you are to pursue your financial goals. Your next step is to build your plan for achieving them.

We highly recommend doing this under the guidance of a financial adviser who is well-experienced in helping people with this type of work, and who has an appreciation for the risks we warn of here at Peak Prosperity.

As mentioned in Step 0, if you're looking for a qualified adviser, we find that inviting them to watch The Crash Course is a good litmus test: if they disagree with it, you'd be better off finding someone else to work with.

If you're having difficulty finding one you like and would like to have a free consultation with the financial adviser we endorse, you can submit a request here.

But whichever adviser you work with, they should use your personal financial statements to craft a personalized plan with you for following the steps laid out in Chapter 6 of Prosper!, including:

  • Determining how much of your money to set aside for investing across the remaining Forms of Capital (your Resilience Building Fund), and how much to keep in your Financial Future Portfolio
  • Allocating the capital within your Financial Future Portfolio
  • Hedging against a market correction
  • Gaining exposure to precious metals
  • Managing debt wisely
  • Investing outside of Wall Street
    • In Prosper!, we mention several opportunities that have caught our attention, including a way to invest in productive sustainably-managed farmland, as well as new solutions like CircleUp that enable direct investment in smaller enterprises, and organizations like Slow Money that direct capital into local food systems. Our podcasts on local investing with Michael Shuman and Bruce Seifer also offer good grounding in how to go about finding returns outside of the public stock markets.
  • Living within (or below) your means
    • Joining our Frugal Living Group will help you learn lots of ways to obtain what you need affordably, or without having to spend any money at all. 

Remember, though, that money is just a means to and end, and that Financial Capital is just one of the 8 Forms of Capital that make up true wealth. Don't let your money define your happiness.