Companies across the world operate in much the same way. They go into business, manage their expenses and try to turn a profit. It is a tried and true concept that can also be applied to personal finance. Think of yourself as your own little company. To make your company run smoothly, you need to take a look at your books. The exploration starts with a comparison of your income and expenses. In this article we'll show you how to apply corporate money-managing concepts to your own financial situation.
Most start-up companies aren't profitable. Their initial funding is spent to get the business up and running. The clock is ticking, and running out of money before turning a profit is the No.1 concern. The rate at which a new company's funding is being spent is referred to as the "burn rate". By tracking the speed at which the money is being burned up, it's easy to tell how long the company can survive. (To learn more about burn rates, read Don't Get Burned By The Burn Rate.)
Applying this concept to your personal finances is easy. Think about your paycheck and view it as the seed money for your retirement, as reaching retirement with an adequate amount of money in the bank is your ultimate goal. If you "burn" through your money too fast, you won't have any left for your savings and you will likely be headed straight into debt as you dip into your existing savings. (Find out more about saving for retirement in Retire In Style, Determining Your Post-Work Income and How To Become A Millionaire.)
If you net $50,000 per year and spend $55,000, you are operating at a $5,000 loss. How long could you possibly last if you are burning though $5,000 in cash each year? Not very long! Unless, of course, you have a huge stockpile of cash in the bank.
At first glance, you may think it's unlikely that you spend more than you earn, but easy credit and bad habits have put more than few people into this category. Also, for many, it is too easy to dip into their savings when a new product or service they want becomes available.
Also, when you buy anything on credit, you can't just count the minimum payment as an expense. You spent the full amount. The minimum payment is just punishment for your mistake. To get your personal retirement on track, you need to sink your money into investments, not credit card payments. Cutting your burn rate is the key to making that happen. Eliminating purchases that result in spending more than you earn is a major step in the right direction in reducing your burn rate. (Keep reading about credit in Take Control Of Your Credit Cards, Credit, Debit And Charge: Sizing Up The Cards In Your Wallet and Understanding Credit Card Interest.)
In the corporate world, there are two types of profit margins: gross and net. Gross profit is your profit before taxes. Net profit is the after-tax figure. In the personal finance world, net profit is the one that matters.
The first step in figuring out your profit margin is to assess how much money you earn each month. The next step is to figure out how much you spend. The spending category includes everything - the big stuff like mortgage/rent, car payments, credit cards and the small stuff like dinners and movies. You've got to subtract the expenses from the income to get the number that represents your profit or what you could put to your savings.
Also, just because you have enough money left at the end of the month to make the payment on your car, dine at a fancy restaurant and have those daily cups of expensive coffee doesn't mean that your company is in good shape. To evaluate your situation further you must look at what ends up happening to that leftover money.
What's Your Profit Margin?
Say that you net $50,000 per year and you spend $47,500 per year. By subtracting the expenses from the income, you come up with $2,500 in net profits.
Dividing the net profit by the net income gives you your profit margin. That's $2,500/50,000 = 0.5. Multiply the 0.05 by 100 to get the number as a percent. That's 0.5 x 100 = 5%.
Why Are You in Business?
Look at your profit margin. You worked all year to earn it, and now is the time to see the results. Your net profit is the net accumulation of all of your efforts. Are you happy with the number? Is it enough? Is that the number you had hoped for and planned for? Will your company survive on that number?(To learn more about budgeting, see How Budgeting Works For Companies, The Beauty Of Budgeting and Ten Tips For Achieving Financial Security.)
On the corporate side, investors would not be that impressed if the company were only generating a profit margin of 1-2%. The greater the profit margin, the more attractive the company is. So, you again need to ask yourself whether your profit margin good enough.
To answer this question, you need to have a goal. You need to know how much money you will require to turn your retirement dreams into reality. If you don't already know the number, and how much you will need to save during your working years in order to reach it, now is the time to figure it out.
Improve Your Profit Margin
One you've figured out your profit margin and your retirement goal, it's time to make a few adjustments. If your profit margin doesn't provide enough revenue to properly fund your retirement savings, it's time to reduce your expenses. Look at all of your expenses that you discovered in your burn rate and see what you really need and which expenses can easily be cut. You will often surprise yourself.
If your profit margin is adequate, increasing it will add a cushion to your plan and may even help you reach your goal early. Being financially free can be a great feeling, so why not get there as early as possible?
Unlike investors, corporations aren't emotional. A solid business is set up to make a profit. Simply paying the bills and breaking even isn't good enough. In your personal life (your own little business) simply paying the bills won't ever be enough to achieve your end goal. Simply paying today's bills won't fund your retirement. Get past the emotions, focus on the numbers, and approach the endeavor in the same way that a company approaches its business. It's a sound plan that has worked for millions of corporations and more than few smart investors.
For tips that can help you get started, read Fundamentals Of A Successful Savings Program.