What will you learn?

1.  
   What is free cash flow?
2.  
   How to keep records of income and expenses
3.  
   How to Build an Income and Expense Report

Through the previous lesson, we realized that personal balance gives a general idea of a person's financial situation.

However, very often the big picture may not be enough to accurately analyze all finances and understand the future prospect of reducing costs. To do this, we will need a more in-depth study of the dynamics, composition and frequency of own cash flows.

An in-depth analysis of income and expenses will allow you not only to look at your financial habits from the outside and understand how current expenses are rational, but also to calculate the free cash flow - the difference between income and expenses.

Audit of income and expenses

If you have never kept records of income and expenses before, you should start with an audit of the available funds. Write down in a convenient accounting tool the current balance of the balances on all bank accounts and the amount of cash.

At this stage, it is better to write out balances only on those accounts that you use to pay monthly expenses.

If some account is used only as a savings account, then it is not worth taking it into account at this stage in order to reduce the number of accounts that require regular analysis.

In order to correctly and without unnecessary difficulties to conduct an analysis, it is necessary to divide both expenses and incomes into categories united by a common meaning.

Categorization of income

For example, income can be divided into several types.

1.  
   Passive income is income from investments in real estate, in stock market instruments or interest on a deposit. It is better to strive to increase this particular item of income, because as soon as the amount of passive income reaches the average size of monthly expenses, you can assume that you have gained financial freedom.

    

   Which of the following categories should be maximized?

    

   What category of income should one strive to maximize in order to gain financial freedom?

   Income from work

   Passive income

   Income from the state

   Income from freelance projects

    

   Cost categorization

   Expenses can be divided according to different principles. Let's show one of the ways.

   Mandatory expenses

   1.  
      Rent payments
   2.  
      Monthly loan payments
   3.  
      Housing and communal services, communication services, Internet
   4.  
      Transport
   5.  
      Groceries
   6.  
      Spending on medicines and medical services

   Optional expenses

   1.  
      Eating out
   2.  
      Entertainment
   3.  
      Globetrotting

   Another possible option is to divide expenses into fixed and variable. In this case, the first category will include all expenses, the amount of which is known in advance and fixed from month to month, and the second category includes expenses, the amount of which changes every month.

   For example, loan payments, rent, telephony and the Internet are examples of fixed costs.

   What are the costs of paying a mortgage?

   Variables

   Optional

   Required

   Periodic

    

   Do not split the costs into a large number of items. The optimal number of categories is not more than ten.

    

   If an item of expenditure is too small, you should not pay much attention to it, you can put it in the category of "other" or combine it with another. Sometimes it is enough to divide expenses into only three large categories to understand where there are problems.

   If the initial analysis shows that in any of the categories your real expenses exceed the approved ones, then it makes sense to dig deeper to understand the cause of the discrepancy.

   It is important to regularly keep records and analysis of your expenses, the only way you can control expenses.

   Income and expense statement

   Now you can make a personal statement of income and expenses, as well as calculate the free cash flow, and otherwise - the amount of income that remains at the end of the month after all expenses.

    

   Don't forget to keep all of your expenses and income in one place. You can use a few tools to record all of your finances. Let's look at some of them.

   Methods of accounting for income and expenses

   1. Paper carrier: notebook, notebook. The advantage of this method of accounting is its simplicity and versatility, even a pensioner or a child can cope with this. The disadvantage is a large amount of manual labor and the complexity of subsequent analysis in dynamics.

   2. Spreadsheets: Excel spreadsheets or cloud-based Google spreadsheets. The advantage of this method is a wide range of tools for analysis and the ability to adjust the accounting to your needs. The downside is the complexity of the tool itself, especially for the elderly, as well as the need to manually enter transactions.

   3. Your bank's analytics: Most banks provide primary cost analytics by category. The advantage here is automation. But if you use cards of different banks or cash to pay, you will not be able to see all the information in one place, which will complicate and distort the analysis.

   4. If the mobile application of your bank does not provide convenient statistics, then ready-made solutions for accounting finance can be found in third-party applications. The advantage of this method is automation and convenience, and a possible disadvantage is the need to pay for the advanced functionality of applications.

   Free cash flow is...

   Difference between assets and liabilities

   Difference between assets and expenses

   Difference between income and expenses

   Difference between income and liabilities

    

   Briefly about the main thing

   1.  
      Free cash flow is income minus expenses.
   2.  
      Expense accounting can be maintained on paper, in Google-tables or in a specialized service.
   3.  
      The quality of expense accounting and analysis depends on how well you have information about your finances. Accounting should be kept regularly, especially in the beginning, when the habit is just being formed.