The Wealthy Freelancer

Start By Pricing Low?

My experience is that the new entrepreneur is often terrified of pricing themselves out of the market and seeks to gain market share by undercutting the competition’s prices.  This seems like a safe strategy, with less experience you should charge less, right?  Well, maybe, but do keep in mind the dangers of underpricing:

• It basically says to potential clients, “Hey, we don’t do as good of work and so, to make it up to you, we are charging less.”
• It sets a bad precedent for future work with that client, who will forever consider you the “discount provider.”
• In the words of a client I was pursuing, “we decided to go with Super Big and Famous Firm X because, although they charge twice as much, we know they won’t nickle and dime us every time we have a question or want something from them.”

Charge by the Hour?

Most entrepreneurs and independent professionals start off charging by the hour.  After all, most of us start our our careers as employees and we are accustomed to thinking of our time as having a price.  “Time is money,” as they say and we want to make a certain amount of money per hour.

Charge Them What You’re Really Worth!

Steve Slaunwhite of “The Wealthy Freelancer” makes a great case for a matter true to my heart, ending outdated thinking of charging by the hour and start charging by the result.

• Clients don’t want your time, they want a a job done!  They come to you because they have a need that needs met and are indifferent to your actual input of time.
• The client looks at hourly billing as a “blank check” for you and worries about the meter ticking.
• It sets an artificial ceiling on your earning power.  As you earn greater efficiencies and produce better work, your income cannot expand accordingly.

However, even though you, as a savvy professional, as charging your clients by the job you still need to track your hours spent on each project.  Your time is a finite resource and you need to manage it carefully.  Tracking the time you spend helps you to price future jobs and shows what lines of work are most profitable .  Finally, it should help you find efficiencies and show what areas need you need to spend less time on.  Two tools recommended by “The Wealthy Freelancer” are www.traxtime.com and www.freshbooks.com.

Determining What Price to Charge

Most new entrepreneurs stumble into pricing the wrong way.  They start off marketing and then get to pricing only when when they are asked about it, figuring that they will take what the client offers.  Well, often the client doesn’t really know what the “correct price” is and they are certainly not going to lead off with their best price.  Besides, nothing says amateur like not even having a ballpark figure of what you intend to charge!  So your first step, according to Steve Slaunwhite of “The Wealthy Freelancer,” is to create fee schedule for the services you offer.  The schedule should set out a range of prices for each service or product and gives you a beginning price.

“But if I don’t have much experience, how much should I charge?” I can hear you ask.  Well, in the Internet age, you should be looking up the fee schedules of your competitors and using that as a basis for how much to charge.  Adjust the price accordingly as you get experience and get a better idea of what your unique customers are willing to pay.

Don’t accept low-ball prices; if you really want the work compromise with them but get something in return, more time, money up front, a reduction in the output., a commitment for multiple purchases.  Remember that every job sets a precedent for all future work with that customer.  If you set yourself up as the bargain basement option then that is what you will always be to that client.

Fire Loser Customers!

My longtime readers know what a huge fan I am of Steve Wilkinghoff and his book, “Found Money”.  One of the highlights of Steve’s book is his “Customer Profitability Map.”  The basic premise is this, evaluate your customers by two criteria, profitability and pleasure of doing business with.  Plot them out on a grid and take the quarter that are both least pleasant to do business with and least profitable and fire them!  The quarter that are both the most pleasurable to do business with and most profitable try to cross-sell and up-sell.  At the very least, keep in close contact with them and follow what they are up to.  Meet with pleasurable but less-profitable clients and determine if there is work that could help them become more profitable.  Be wary of more profitable but less pleasurable clients.  They may be worth the hassle but keep an eye out for hidden costs and potential drains on your time and efforts.  Finally, if they should ever fall into the less profitable category, fire their asses!

I Can’t Recommend Enough

I had the honor of writing a guest article for Small Business Branding on selling your business.  It’s a lot of fun and with some great pointers to keep in mind, if even you’re not ready to sell yet.

Getting it online

In the digital age every bank has an online presence, from my little credit union to the big national players. However, not all banks are geared toward serving small business via the internet and, while they all offer you a lot of promises and maybe a flashy new toaster oven, not all of them offer you the services that you need at a competitive price. Here’s what to look for and how to spot those that offer online small business banking from the poseurs.

Customer Service and Big vs. Small Banks

One thing that you may read is how important it is to “cultivate relationships” with your banker and how important your banker is in expediting and even deciding whether or not you get a loan. While this may still be true in the smaller banks, in larger regional or national banks you will never, ever meets the person who approves your loan. A buddy of mine who was a big shot at a major bank before ditching it all to go into the Peace Corps said that the big banks create a strong separation from the banker that you meet, who is basically a sales person, and the person who decides, who is basically an accountant. So skip bribing your banker with chocolate truffles or bottles of bourbon. In fact, if you already bought the “gifts,” just send them here and I’ll gladly dispose of them for you for free!

Similarly, once the recommendation for business people was to keep all their banking with one bank, in order to build up a relationship of trust with that bank. Now, however, the idea of relationship is breaking down and, thanks to the internet and the relative ease of online banking, small businesses can cherry pick the best services off a smorgasbord of banks just like the Bigs do. In fact, the biggest reason that I can see of deliberately keeping all services with a single bank is not having to remember more than one sign-on, password, and pin!

What Your Bank Should Be Able to Do for You

Business Checking Account

One of the essential elements of running your own business is treating it as a separate entity distinct from your own personal affairs or the affairs of your other businesses or investments. Failing to treat your business as a separate entity opens up numerous potential legal and tax consequences that could end up being very costly or even financially disastrous to you. Opening up a business banking account is one essential act that helps establish your business as a separate entity. For most business the key to the checking account is functionality, forget interest rates and a few dollars difference in cost. The key questions are:

• Can you use the web site to pay pre-pay bills, transfer money, accept online payments and whatever other essential services that your business might need?
• Are you able to easily download information from the online site to QuickBooks Online or whatever other accounting software that you might be using?
• Do they have the highest level of online security that is convenient for you?
• Are they relatively light on “hidden fees” that $5 and $10 you to death just to be able to perform regular, essential operations of your business?

Security
Small businesses run by new entrepreneurs often have lower standards of security and this is especially true when it comes to banking and banking online. The smalls just don’t have the expertise nor the payrolls stuffed with I.T. professionals to keep up with the Trojans and frauds that cyber-criminals use to prey upon the unfortunate, and the unwary. You want the highest level of security possible but without making it so inconvenient on yourself that you aren’t fully able to take advantage of the online services. For example, while I was a Peace Corps Volunteer in Guatemala I often had to do my banking from internet cafes, and not always with my laptop that was impractical to lug around. When Chase, my original bank, changed the security so that I had to go through a complicated and time-consuming process every time I tried to access my account from a different computer I had to change banks (rather, I added a new bank) because that just wasn’t doable for me.

Loans and Lines of Credit
Loans are a prime area of shopping around and using the power of the internet to shave a fraction of a point off the interest rate. However, if you can’t pay the loan through an electronic transaction between the bank of your checking account and the bank that services the loan and make that payment for free then who cares about a little reduction of the interest rate. I like to look around for the best deal and then ask my primary bank if they can match it, just to keep my life as simple as possible.

Credit Cards
One of the easiest ways to make payments these days is by credit card and you will want at least one that is exclusively used for business purposes. There is no “best” credit card for small business and usually your bank will be able to provide you one. Keep in mind that you want one that is easy to set up and maintain electronically, that is widely accepted (especially if you travel for business), and has a high enough limit for what you need. Remember that building up credit for your business is just like building up credit personally, the better your history the higher your limit will be.

In Conclusion
Starting up a small business can be intimidating and the days when you could have a banker hold your hand and guide you through the process are long gone.  The flip side of that is the incredible amount of information available to you at your fingertips.  Another advantage is that you are no longer geographically limited, a world of banks is waiting to serve you!  Just remember to keep in mind the services that you need, those that you don’t need, and those that you need but could be found at another bank for a better price.  Happy banking!

Health Insurance

Being self employed is fantastic!  There is no one to tell you what time you need to be at work or what you have to wear or to pay for your health insurance and for half your payroll taxes.  What?  Gotcha!  Many new entrepreneurs overlook the need for health insurance and just how much it will cost them when they strike out on their own.

You MUST Have It!

Right after I got out of college I shook the dust of Indiana off my feet and headed down to someplace really fun, Miami.  I had a fantastic time working odd jobs and trying new things out for a year until, one visit home my father gave me one of those fatherly lectures; not about finding a career but about finding health care!  “What if something happens to you, what do you think your mother and I would do, just let you die or suffer?  You know we would spend our every last dollar trying to save you, is that something you want on your conscience?”  Grief stricken at the thought of my parents staring at my lifeless body in a casket, contemplating their future with no son and no money, I went to grad school for finance, ended up in accounting, and the rest is history.
“So what?” you shrug.  Well, no one ever thinks it is going to happen to them but it always happens to someone!  So, if you don’t get health insurance for your sake, do it for your mom, she’s worried sick!

Mom & Dad

“Alright,” you grumble, “but where do I get health insurance that won’t cost too much?”  Try starting with dear old Mom and Dad.  You see, with the new Obama-care health insurers are mandated to offer health insurance to all children up to age 26, irregardless of whether they are in school or not.  In fact, most of the big insurers, including United Health Care, WellPoint, CIGNA, and Blue Cross & Blue Shield are already in the process of implementing this.  Also, a few states already require that insurance be available for children up to age 26, or even older.

Spouse’s Job

Hey, this is one of the reasons so many self employed are married to school teachers; they can still get the good benefits that way!  An obvious resource but one that shouldn’t be overlooked.

Day Job

So what if the significant other doesn’t have a job or their current job doesn’t offer health benefits?  Well, head over to your nearest Starbucks, Whole Foods Markets, or local government branch and pick them up an application!  There are some employers who still have a reputation of providing quality health benefits at an affordable price for their employees .  Better yet, pick up two applications because you may want to consider getting a day job yourself until your business takes off.  Check out employers with flexible or alternative hours that will leave you time to work on your business after hours.  Hey, once I even worked as a parking lot attendant and could have worked on my business even as I got paid (and insured) on my regular job.  Of course, I squandered that time studying.

Trade organizations

If you’re too old (or an orphan), not married, and don’t think that a second job would work for you than the next step is to look toward any trade organizations that you might be a member off that might have a health insurance package.  Also try your local chamber of commerce, AARP if you’re over 50, and the Small Business Services Bureau.  A fabulous resource is Health Insurance Info Net by the Georgetown University Health Policy Institute that gives up to date information on a state-by-state basis; including sections for small business and the self employed.

Insurance broker

It is the insurance broker’s job to help you find the right insurance package for your needs and the option shouldn’t be overlooked.  Just do remember that, as with any broker, your interests and those of the broker are not always in alignment and therefore shop around first to get an idea of what your other options are.  Comparing health plans is tricky, because there are so many variables all of which will be important to different people.

COBRA

If you’re leaving a job to go out on your own, don’t forget to get signed up for COBRA before you go.  COBRA basically gives you the chance to continue your current insurance, under your now ex-employer, for up to 18 months after you leave that employer.  This buys you time and allows you the chance to shop around some.  With COBRA, however, you pay 100% of the cost of your coverage, so no employer subsidy.  Do not let your insurance lapse!  When you eventually pick up a new insurer you don’t want the to say whatever you need taken care of was a pre-existing condition.

What’s your experience with health care?  Did you find it a difficult part of the transition from being employed to becoming an entrepreneur?

Please leave your questions or offer your solutions below. As the WebCPA and the author of WebBizFinance.com, my job is to help you grow your business and solve your business finance and accounting problems!

Tyler

Big Dollars For My Biz

Also, value is in the eye of the beholder; a banker will have totally different criteria than a potential business partner or investor.  Below are some of the principle factors in calculating the value of your business as well as a listing of professionals that could help you put everything together and arrive at a number.

Principle Factors or Methodologies in Valuing a Business

1. Discounted Cash Flow – this is the methodology famously endorsed by Warren Buffet when he evaluates a business.  In its essence it involves taking the amount of cash flow you expect a business to generate in the future and then discounting that at some rate (perhaps U.S. long term t-bills or your required rate of return) to get a present value.  The math is simple using Excel, but this methodology obviously requires a great deal of estimation.  Don’t let the preciseness of the number fool you, in fact, you may wish to get a range based upon several different estimated cash flows and let that be a general guide.
2. Value of underlying assets – this is what would concern your banker or the court-appointed trustee of your bankruptcy.  Basically, this would require going down the balance sheet of your business and marking everything to its value if you had to sell it right now and then subtracting what you owe to others from that.  The problem with this methodology is that it only works if your business sucks.  What if your business requires very little capital to be successful but still kicks out tons of cash and profits each year, which you then use to line your pockets?  Clearly this methodology would grossly undervalue your business.
3. Growth potential – This is how the internet businesses of the dot.com bubble era got their outrageous valuations.  If your industry is hot enough and your business plan is sexy enough then your business may be extremely valuable even though your profits and cash flow are negative and your liabilities are greater than your assets.  In other words, people would be willing to put money into it now to keep it going until the day that they gamble it will really take off and pay them back many times over.  Pretty much every business starts this way, the owners invest time and money now in hope of future profits down the road.  Evaluating that “future profit down the road” is more of an art than a science.
4. Comparable business - You see this all the time in the stock market, the stocks of certain sectors correlate with one another because businesses from the same industry face similar economic realities and thus when one is sold it provides a benchmark price for all similar businesses.  Sure, you can expect your business to be worth more or less depending upon factors unique to it, but a potential appraiser might take that other business as a basis and then make adjustments to it to get to the value of your business.
5. Synergies - often when an existing business business is purchased the buyer is another business that is looking for synergies that can be exploited by uniting the two businesses.  The synergies could come in the form of uniting new technology, more efficient purchasing through economies of scale, lowering cost by sharing overhead, or cross-selling in complementary markets.  For a big business example think of a big pharmaceutical company buying out a bio-tech firm to access new technology and diversify its products.  Closer to home, if you run an online store that specializes in hip handbags for young, professional women you might be bought out or merge with another online retailer that has a niche in chic but not-too-expensive jewelry for a similar clientele.  The merger would allow them access to your client lists and a chance to cross-sell their product through your channels, as well as the continued revenue of your business.  This creates synergy and might mean that your business would be more valuable to this potential buyer than to someone who doesn’t yet have an online presence.

A Second Opinion

A number of professions have sprung up that provide specialists in valuing businesses.  The BizSeller has already put together an excellent list, so I will use an excerpt of their post and add hyperlinks to the institutions mentioned.

• Initials: C.B.A.   Title: Certified Business Appraiser   Institution:Institute of Business Appraisers
• Initials: A.S.A.   Title: Accredited Senior Appraiser   Institution: American Society of Appraisers
• Initials: CPA/ABV   Title: Certified Public Accountant Accredited In Business Valuation   Institution: American Institute of Certified Public Accountants
• Initials: CVA   Title: Certified Valuation Analyst   Institution:National Association of Certified Valuation Analysts

Why would you need a specialist? Usually, if you are calling in one of the above professionals, it is because you are being asked for an independent third-party valuation by a potential lender, by the courts, or you need to provide it for estate tax purposes.

How does the specialist arrive at a price? Usually the specialist takes the factors above that they feel are most relevant to your business and then run a set of calculations using a range of factors.  They do the math several different ways to provide a range of potential values and then they pick a number and the middle of the range and then, abracadabra, just like a magician pulling a rabbit out of his hat the specialist pulls a number out of her, well, range of numbers.  This is great fun in divorce cases or other legal cases because you get two specialists, one representing the plaintiff and the other the defendant, coming up with two very different values.  Almost invariably each specialist (expert witness, in this case) chooses a number that favors the party that pays them.

Conclusions

• The business has different values to different people
• There are many different ways to value a business
• Retained Earnings have little to do with value
• Earnings + positive cash flow = great business, earnings + negative cash flow = future bankruptcy ,

Please leave your questions or offer your solutions below. As the WebCPA and the author of WebBizFinance.com, my job is to help you grow your business and solve your business finance and accounting problems!

Tyler

More Time/More Money

Since reading “Found Money, Simple Strategies to Uncover the Hidden Profit and Cash Flow in Your Business” I have developed an enormous man crush on Steve Wilkinghoff.  Really, if I had a poster of him I’d put it up right between the ones of Michael Bradley and Voltaire.  I cannot preach too much that, in my experience, there is an overwhelming correlation (I would maintain causation!) between businesses that take accounting and financial management seriously and businesses that make their owners rich.  Now Steve comes along and gives the world’s productive class new tools to make themselves more money and give themselves more time to enjoy it with.

Found Money is the type of book that elevates accounting out of some crap that the IRS requires and into one of the sharpest tools in the entrepreneurs tool chest.  Steve’s Found Money Method not only tells entrepreneurs what the important influences on their business’s profitability are, it gives them the tools to maximize that profit potential and do what every good business must do, put money in its owner’s pockets!  Some of the nuggets of wisdom from Found Money include:

• Why “Getting More Customers” is often the most ineffective method of growing your business.
• Why it isn’t enough that your business is profitable, it must also be cash plow positive and provide a sufficient return on investment.
• Why the worst method of marketing is often the first used.
• Why some of your customers are most likely taking money out of your pockets and how to find them and fire them!
• How to find out which of your products is really making you the most money and what products you want to sell more of.
• Why most businesspeople actually under-price their products and how to find the best price for your products.

How much would that information be worth to you; perhaps thousands, maybe even millions of dollars?  Steve’s book set me back about $15 including shipping when I bought it online.  Only I had to buy it twice because I lost the first copy after reading just enough to get me really hungry for more.  Big Business spends gigantic sums each year poring over their accounting records and using them to make the important decisions that are often life or death for a company.  Now Steve puts this ability in your hands and adds the Chief Financial Officers cap to the Chief Executive Officer’s and Chief Operating Officer’s caps that you already wear.

As the WebCPA and the author of WebBizFinance.com, my job is to help you have more time and more money!

Tyler

The Indirect Method

The Philosophy of the indirect method is that cash flows should be in essence driven by profits so, to calculate the indirect method of cash flows, you start with your profits and then make adjustments for everything that are not profits until you get to your change in cash flows. When you think about it, this is very intellectually satisfying. After all, our main obsession is with profits, and rightly so. However, profits don’t keep the employees coming back and the lights on, cash does. So by closely examining all the uses of cash we can see where our cash is going and locate any potential problems; which makes the indirect method of calculating cash flows a fast, efficient, and very powerful weapon in your arsenal of business management for maximum profits!

Balance Sheet for Cash Flows

The Trick

Debits equal Credits and the balance sheet must balance, or assets = liabilities plus equity, got that? That’s all the accounting you need to know for this exercise. Now take this a step further. Download your comparative balance sheet into Excel, you know, it’s the assets = liabilities plus equity page. Comparative means that we show two periods, usually year ends, side by side; like in the first graphic. Now, in the immediate column to the right make a total subtracting the current periods assets from the prior periods and copy it all the way down, except in the totals cells [see the first image]. Now move down to the liabilities and equity section and do the opposite, subtracting the prior period from the current period. We do the opposite because credits (liabilities and equity) have the opposite value (-) from assets (+), but that’s really not important at the moment. Now sum the new column that represents the change in the balance sheet. If you did the exercise right then the sum should be zero. If you’re not getting zero that means that you forgot to reverse the formula for the liabilities and equity section or you included subtotal rows in your new column. Pretty frickin’ cool, huh? But that’s not the coolest part. Now redo your sum to exclude the difference in cash, usually the first line. The sum of all the other changes is exactly opposite the sum of any single change, or in other words the sum of every other row times negative one equals the change in cash flows!! Flippin’ mindblowin’ stuff! And the basis of the Indirect Statement of Cash Flows.

Statement of Cash Flows

Putting This Into the Statement of Cash Flows

You’re 80% of the way there and, if you are only doing this to understand your business and not to make a real, bona fide, according-to-GAAP cash flow statement then skip over the rest of this post and head to the next. The next step is to turn this information into the required format to have an official looking statement. Well, if you take a look at my sample Cash Flows Statement you will see that the first line is net income, and what is net income but part of the change in retained earnings? If you read my earlier post on retained earningsyou will remember that the change in retained earnings is comprised of net income plus capital contributions less distributions. So your net income, the first line on your statement, less your distributions or plus your contributions in the investing section will equal your number for the change in retained earnings on the balance sheet you worked on in the paragraph above. And so it is down the line, every line on your cash flow statement must either alone or in aggregate with another line equal a line in the change column that you just calculated on your balance sheet. This is brilliant stuff kids and I wish my accounting professor would have explained to me this way. Actually, maybe he did but perhaps I was tired from the long work day and then school and was taking a little nap.  Oh well, ya snooze ya lose!

The Challenges

The next big challenge on your statement of cash flows will be the change in fixed assets, which will be a component of plus depreciation expense less any new assets purchased plus any assets sold plus or minus the gain or plus the loss on that sale. The key is, when you add up those factors they must equal that line for the change in fixed assets. If not you’re forgetting one component so review the equation in the first sentence of this paragraph and figure it out.

After fixed assets the next most complicated line is the change in notes payable or debt. The formula is that new monies borrowed minus debt payments plus interest expense will equal your change in debt. This is important because all three components will go on a different line on your statement of cash flows, but their sum must equal the change that you calculated on your balance sheet or you’re doing it wrong and you need to review.

Other than that everything else pretty much matches line for line between your balance sheet calculation and the statement of cash flows. Just plug in the numbers and voila! your change in cash flows will equal the amount that you calculated on line one of your balance sheet! If for some reason it doesn’t just go back over and make sure that you can reconcile each line for the changes that you calculated on your balance sheet to the cash flows statement. If you can’t you must be missing a line.

Finished, Miller Time!

When you’re done patting yourself on the back for a job well done then it is time to get down to the really important business, what all this madness means to you and your business and how the statement of cash flows can help you run your business better. Alas, that is the source of another post as I’m tired and turning in for the night; so stay posted!

Any questions? Do you think that this is absolutely brilliant and that all business people should make a pilgrimage to the grave of the Portuguese bookkeeper who first invented this madness 500 years ago? Do you think I am a moron and have no idea what I’m talking about? Feel free to let me know in the comments section below.
As the WebCPA and the author of WebBizFinance.com, my job is to help you have more time and more money!

Tyler

Top 5 reasons for preparing your personal financial statements at least once a year:

1. You can keep track of all your investments in one place. If you’re like me then you have a 401(k), the wife a 403(b), an IRA, and a few miscellaneous investments in comic books, antique chamber pots, and real estate in third world countries all on separate reports. I like to put their values all on one financial report each year to get an idea how my portfolio is performing as a whole. This way, if I am assassinated in the night by anti-capitalist accountant-haters, my wife will have a summary of our assets or, if I live, I can see if we need to do some diversification of the family portfolio into say, cocoa bean futures or works of art by minor Midwestern celebrities.
2. In case someone wants to see them. For example, if you are applying for a loan with the Small Business Administration, if you are about to take on a business partner, or if you are engaged to be married and are about to ask your future father-in-law for permission then there are people who would be very interested in seeing what your resources are and how responsible you are in managing them!
3. To examine where the money is coming from and where it is going. This is a hard look at the income side of the statement. I like to put my expenses into categories and compare how much I am spending in each category from one year to the next. That way, if I notice a big increase in a certain category, say “Wife’s Boyfriend,” I can nip that excess spending in the bud before it gets out of hand!
4. It can be the basis for preparing the budget for the next year, or for making goals for the next year. My wife and I are saving to buy a piece of property in Costa Rica and we need the cash by August. Using this years budget we projected the cash we would normally have by then and then made some adjustments (she and I working harder and us all tightening the belt) to get to the necessary sum. If we didn’t have this information then we would be flying blind, with only a vague guess as to how much we could reasonably expect to have.
5. Celebrity endorsements; Robert Kiyosaki, in his book Rich Dad’s Prophecy, says about personal financial statements “all through this book, I refer to financial greats such as Warren Buffett, America’s richest investor, Alan Greenspan, chairman of the powerful Federal Reserve Board, and Paul O’Neill, the secretary of the treasury, who all say basically the same thing my rich dad said to me. All of these financially smart men stress the importance of financial literacy and that financial literacy begins with a financial statement. None of these men said start with real estate, savings, a business, tax liens, stocks, day trading, options trading, or mutual funds, which is where most people start building their arks … and that is why so many arks cannot stand rough seas.” Wow, not only does Robert recommend them, he implies that Warren Buffet, Alan Greenspan, and Paul O’Neill do as well!

What they are

So, have I sold you on the value of preparing your personal financial statements yet? Great! So next you will want to know how. The essence of a statement of net worth is the total of items that you own that have value (assets) less the total of your debts and future obligations (liabilities) equals your net worth. Investopedia has an excellent page that gives the details of what to consider for assets and liabilities. The essence of the cash-based statement of income is total income (your salary, payments received for jobs or sales, etc.) less total expenses (money spent) plus (less) any increase (decrease) in the value of your assets that were not the result of putting more cash into them equals your net income, which is the same as the change in your net worth from the prior year to the current year. Got it? Take a look at this sample brought to you byprovided by the AICPA (Professional Bean Counters of America).

There are two essential elements to any financial statements, the first is that the statement of net worth, which is called the Statement of Financial Condition here, has at minimum two consecutive time periods represented and the second is that the statement of income, here called the Statement of Changes in Net Worth, sums up to the difference between the two periods. To put it simply, your statement of income explains the change in net worth over a period of time, usually of one year. So, if you can get your net assets correct and then your income has to be correct as well, you may have to back into it (the technical term in accounting for this is a plug) but there you are!

Below are links to several free templates that will allow you to put together your own personal financial statements. Please note, in order to maximize the entertainment and utility values of preparing your own personal financial statements, I recommend pasting as many prior years as possible into the spreadsheet. That way, 2008 aside, you both get the heady rush that comes from seeing steadily increasing net values march across your screen and you can start crunching those numbers, calculating different ratios and comparing your performance over time. I warn must warn you, it is such an incredibly satisfying experience that you may find the hours go by until you squander an entire weekend just playing with the numbers!

Caveat Preparer, there are many philosophies about what exactly should go onto your statements; the AICPA has one way, Robert Kyosaki has famously made the case against including your residence, and the SBA has their own criteria. My opinion is that you really don’t need to expend gigantic amounts of time into this project for it to be useful. Stick to a method and be consistent over time. I rent, but if I had a house I’d probably include it at the price I paid for it less the amount I owed for it. I definitely would not include my car or any personal property though; the valuation would get to be a hassle and that’s not the point for me. I want to know how much my investments are going up and what I am spending my money on. On the other hand, if the debt you owe on those items is greater than their value, perhaps you do want to include that in order to be conservative.

What about you? Can anyone recommend some nifty spreadsheets or templates? Has it been a worthwhile experience to prepare your own statements? Is there anyone as geeky as me who can’t leave a comment because they want to do theirs right now? Let us know!

Templates

http://www.spreadsheet123.com/ExcelTemplates/personal-financial-statement.html

http://tyronesolee.googlepages.com/personalfinancialstatement.xls

http://office.microsoft.com/en-us/templates/TC010175221033.aspx?pid=CT101172761033

Blogs

http://tirikuimbakul.blogspot.com/2009/12/introduction-to-my-book-young-money.html this Cat is from PNG!

http://www.mikefanelli.com/2009/09/personal-financial-statement-template/ Another CPA with his own blog, trust him, he’s a professional!

http://shanelyang.com/2009/12/02/rich-dads-prophecy-part-4/ a Robert Kiyosaki disciple that gives Robert’s idea of what should be included.

http://www.millionaireacts.com/1734/preparing-your-personal-financial-statement.html Includes a sexy template by Robert Kiyosaki

When I finally got around to getting my first professional job, after college and grad school, working fun but not lucrative jobs, and volunteering in the Peace Corps, I just signed up for the default retirement plan option, probably 3% of wages in a conservative investment, and forgot about it.  It wasn’t until a few years later, now married and with a kid on the way, until I finally started to think that maybe someday I would want out of the rat race and that, if I planned to do so before being eligible for Social Security, it was going to take severe and drastic actions and a whole hell of a lot more than 3% of my wages.  Hopefully, some of our pain can be your gain if you decide to make the Big Push and get caught up.  So read-up and learn-up, I can get you started and suggest some strategies to get ahead.

Preparation
The first step is a realistic look at where you are at and why you are there.  Also critical is analyzing the resources that you have on hand, i.e. your time and labor, those of your significant other, the savings and assets you have to date, and your current rate of savings.  Bloomberg has a retirement calculator that can help you calculate how much you will have upon retirement based upon various assumptions.  It can also help you figure out what you will need to come up with to achieve the lifestyle that you want when you retire.
All hands on board
90 something percent of readers are or will be in a long-term relationship and the absolute, most crucial element for them is whether their partner is on the same page as them.  This is especially true if one works for wages and the other doesn’t; after all, you can’t expect the stay-at-home partner to be as excited or interested in retirement as the working one.  My only real recommendation is constant and open communication about life goals and to make every financial decision beyond the trivial as a couple.   If your partner is pushing for more spending and new baubles now while you are trying to cut back to put more into savings then you will be swimming against the tide.
What are you willing to sacrifice?
You absolutely have to make sacrifices, there is no way around it.  It is going to cost you some combination of time, money, and effort no matter how you do it.  The amount of pain in sacrifice you put in the short term will be directly proportionate to the reward that you receive in the long term.
A hard look at where the money goes
Do you keep track of and categorize your expenses?  If you don’t know what you spend and where the money goes you will have a difficult to impossible time coming up with the necessary cash for savings.  Even if your strategy is to make more money, IT WILL FAIL if you cannot maintain or reduce your expenses.  This doesn’t mean hours each week balancing checkbooks or making sexy pie charts, with most money software like Mint it is almost effortless to track the money spent with credit and debit cards and in checks.  Of course, its not the tracking that makes the difference, its the analyzation and utilization of the information to make better financial decisions.

Strategies

• Spouse gets Job – If you are a one income family with two adults the most obvious solution is for the other member to return to the workforce.  This will only be effective, however, if a large portion of the money they make goes towards the savings and retirement plan.  Since, as previously mentioned, a spouse that wasn’t working before isn’t likely to be as motivated toward saving for retirement, it is essential that the couple keep communications open and plan together for life’s big financial decisions.  Two incomes also gives you the advantage of being able to take advantage of two different retirement plans, significantly increasing the amount you can save and also taking advantage of any employer matching or other retirement contributions.
• Second Job – A second job, well thought out and done appropriately, can not only bring in extra money for savings but can also advance your career, open new doors and even give you the chance to try out new jobs or careers on a part time basis without fully committing yourself.  Done poorly it can still bring in extra cash but at the cost of wearing yourself out from overwork, distracting you from your true calling, and distancing yourself from loved ones who struggle to find time with you.  Quality opportunities are more often made than found, and you will usually, unless your profession happens to be in great demand, have to put some effort into encountering them.  Aggressively seek out opportunities that complement your current vocation and studies and then build upon those.  Currently Ramit Sethi of I Will Teach You to Be Rich is running an excellent series for those who are interested in earning some cash on the side.
• Start a Business – For many owning their own business seems ideal, a chance to be their own boss and master of their own destiny, not to mention becoming Bill Gates rich.  Indeed it is possible, if improbable, especially if one is in a field that is rapidly growing and changing and presents new opportunities.  Most of us would be satisfied with rather lessor fortunes and, with good ideas and plenty of sweat, can achieve success in our endeavors and drastically increase our net worth.  The own-business plan does have several drawbacks that need to be taken into consideration: first, usually a great deal of effort has to be made for what is, in the beginning at least, a very uncertain reward, second, most businesses require some capital up front which we are already lacking in, and third, many people find that their business becomes very much like the job they were trying to avoid only without the benefits of a certain paycheck and the support of bosses and coworkers. Steve and his wife at My Wife Quite Her Job did just that and, while not exactly rubbing shoulders with Bill Gates yet, they are a long way toward achieving their financial goals.
• Downsizing – Another important possibility is cutting back on the money you spend, drastically.  This sometimes requires lifestyle changes that can be abrupt and shocking.  Think about how much you need to set aside, add an additional 20% for contingencies, and then sit down with your significant other and figure out how to cut some of the fiscal fat from your budgetary diet.  My personal belief and experience is to think big, don’t dither trying to save up a latte a day’s worth of spending but look at anything that requires monthly expenditures, the house, the cars, utilities, insurance, cable, and anything else not yet paid off.  Most people are risk adverse, and have an aversion to realizing losses because it is tantamount to admitting failure.  What they often don’t account for are the extra costs, premium gasoline and expensive parts for the fancy foreign car, the maintenance, utilities, and furniture of the top-of-their-budget house and so on.  Often selling out and moving down is the real long term bargain.  If you really want to get dramatic, try living on what you would receive in Social Security given current expectations, that can be a real shock to the system and a motivating force!  Visit J.D. at Get Rich Slowly for fantastic advice on budgeting, saving, and living frugally.  The fascinating thing about downsizing is that people often find that they actually enjoy their lives much more after the initial shock wears off.  No time is taken away from your family and a huge amount of stress can be lifted by not having financial problems and by not having the pressure of keeping up with the Joneses.  Taking vacations by camping out and visiting national or state parks or visiting family can be much more rewarding than cruises, resorts, and amusement parks.  Also, some people actually have fun by thinking of creative ways to cut costs.

This simple article can only touch upon this incredibly important and timely issue.  So help us out, have you started the Big Push?  Can you share ideas that I have overlooked?

Most of us make our retirement contributions the traditional, vanilla way: as tax-deferred contributions to a 401(k), IRA, or other retirement account.  Your rich Uncle Sam is giving you a bye on paying income taxes (but critically not payroll taxes) on the money you contribute in the current year so that he can get it back with interest when you start taking it out at retirement.  Our pal Roth, however, turns the tables.  You pay the taxes now in return for the ability to withdraw the earnings tax free upon reaching the age of 59 1/2 (if you have held the Roth at least 5 years).  You’ve already paid the tax on the money you have contributed, the principal, so you can usually withdraw that without paying any additional tax on it.  But why would you want to pay the taxes now?  After all, we’ve all heard of the time value of money, a dollar today is worth more than a dollar in the future.  Well, please allow me to make the case for the Roth.  I am compiling these with an emphasis on the advantages that are most likely to be attractive to the average Web Biz Finance reader, youngish, entrepreneurial types (should I add urbane and attractive as well, or would that be sucking up?)

The Advantages of the Roth

• It effectively enables you to increase the amount you contribute to the plan by front-loading the taxes.  The maximum annual contribution to an IRA (Roth or traditional) is currently $5,000.  Think about it, 5 grand that you will withdraw tax-free is always better than 5 grand you will have to pay taxes on, right?  The kicker is, it’s the rate that you will have when you take the money out that determines how much better.  Money Chimp has a cool calculator that explains this and allows you to, well, monkey around with the numbers.
• The ability to withdrawal contributions tax free prior to reaching retirement age gives you additional flexibility and, in theory at least, should allow you to be more aggressive in contributing.  Of course, if you don’t trust yourself with access to the money perhaps its better to have it less available.
• If you expect to be in a higher tax bracket in the future than you are now than the Roth plan can save you the difference in taxes.  Let’s say that you are a starving young professional in the 25% marginal tax bracket but you’re working hard, you’ve got a business on the side, and you expect to get into some big money before long.  Or, perhaps you think that tax rates are going to have to go up to pay for the TARP, the wars, and all the other expenses that our big spending Uncle Sam is racking up on credit.  Either way, you can lock in at your current tax rate and avoid any future uncertainty.
• You can both continue to make contributions after reaching age 70 1/2 (in a traditional IRA you cannot) and, even more important to most of us, you don’t have to make required minimum withdrawals at age 70 1/2.  The former is a nice tool for estate planning and the latter gives you both more flexibility and less paperwork.

The Disadvantage

The Rollover

Investors with traditional IRA’s and Adjusted Gross Incomes of less than $100,000 have long had the option of rolling over their traditional IRA into a Roth IRA.  Of course, to do so they have had then declare the entire value of their IRA as taxable income in the year of the rollover and pay the income taxes on it.  This can be quite a shock to your cashflow, as you can imagine.  2010 though, is special.  For 2010 only the income restriction has been lifted, letting the big money people in on the game, and the taxpayer is allowed to pay the tax over two years, numbing the tax blow a little and easing possible cash-flow issues.

Who Should Consider Rolling Over
An excellent article in the Journal of Accountancy does a great job summarizing if you could benefit from a rollover.  You could benefit if you:

• expect to be in a higher tax bracket when you retire
• want access to your IRA funds in 5 years or more but at less than 59 1/2 years of age.  Remember, one of the advantages of the Roth is that you can remove your contributions tax free at any time and only the earnings would be subject to penalties.  If you wanted to take your money out and use it for a non-traditional retirement, or to invest in a business, or to just plain squander it you could roll it over into a Roth, pay half the tax in 2011 and half in 2012, and then wait out the “seasoning period” (five years from the year of the rollover) and then withdrawal it without being subject to penalties.  This isn’t in the Journal of Accountancy but I could see this as being interesting to some readers.
• don’t plan on needing to use the money at age 70 1/2 and don’t want the hassle of minimum required distributions.
• are young and have a high income.
• Would like to pass money onto your heirs tax-free.

The Roth vs. traditional IRA question is an interesting one.  As with most strategies, one size does not fit all.  Below are some references for additional information.  Let me know it you’ve thought of something that I’ve missed!

The Wikipedia page on Roth IRAs.  It includes a pros and cons section.
Straight from the horse’s mouth.  The IRS gives the skinny on all the technical issues surrounding the Roth.
Investopedia defines the Roth but, more importantly, they provide links to multiple articles that give the who, what, why and where of the Roth.