Saturday, November 28, 2009

An individual as a private company

I've been toying around with the idea that you can treat an individual financials as though it belongs to a company. Long time ago, as I was learning how to read financial statements - those pesky cash flow statements, income and balance sheets - I didn't realise that reading those are similar to an individual's statements. Let me illustrate:

Suppose I earn 100k in a year, but spent 70k, thus my savings would be 30k. Isn't this similar to a company with revenue of 100 mil in a year, 70 mil spent on costs, leaving 30 mil profits? Here's the interesting things:

1. Just like one can calculate a company's profit margin (profit/revenue), one can also do the same for a personal financial statements. Savings ratio (savings/total income) is very similar to a company profit margin and the analysis of it can equally be applied.

My savings ratio up to date is 60%. I didn't use total income, but used the basterdised version of it - total cash out/total cash in on a monthly basis (due to the nature of my job, there's a big difference between my income and the cash I get per month - that's another story for another day). It's lesser than last year, which goes around the insanely high amount of 80% on average. But hey, I'm happier this year and I definitely saved more in absolute amount. No regrets on spending money on people around me :)


2. A company that holds too much cash is not good because cash itself is not going to generate a good returns for the company. If you hold too much cash, you'll start to wonder if the cash is really there in the first place (think ass-shares). Similarly, for an individual to hold too much cash in the form of fixed deposits or savings accounts, it's going to reduce one's ROE (not the thingy that you eat on sushi - it's returns on equities).

For me, my ROE this year is definitely going to be low because I'm holding more cash than necessary. Why ah? "Me private limited" is going to have a amicable takeover with "her private limited", where the former is going to assume any profits and liabilities owned and owed by the latter. The impending fees involved would thus be reason enough to hold some cash to tide it over. Hopefully it's a good investment for me private limited :)


3. A company with weak balance sheet can withstand the storms of the business world. Likewise, a person with weak balance sheet cannot weather bad patches as well as someone with stronger balance sheet. What's weak balance sheet? High debts, low in cash high in 'assets' like cars are two things that come to my mind.

Here, we have an interesting situation. Too little cash is no good. Too much cash is not good too. Different companies have to adjust this cash ratio to suit their purpose, I suppose an individual have to do the same too. Just bear in mind the risk of holding too much cash.


Think I'll stop here. The good thing about learning to analyse companies is that you can analyse yourself as a company too :)

13 comments :

Musicwhiz said...

Hi LP,

They have a term for 2 Balance Sheets merging together. It's called "Amalgamation" and describes Marriage pretty well! Two Balance Sheets merging to form one but then the wife usually has more control over the Cash Flow Statement eh? Haha.

Just make sure you build up your "retained earnings" with "positive cash flow". If not, one will end up with a decaying balance sheet and a lot of trouble should creditors come knocking on your door.

And oh yes, cars though carried at cost on one's personal balance sheet, actually have a NAV which is much lower. We call it written-down cost and the difference is charged to Income Statement as Impairment Loss! Hope this isn't too technical.....hehe

Regards,
Musicwhiz

Createwealth8888 said...

Hopefully your future wife doesn't say: "My money is my money. Your Money is Our Money."

Actually, all wives must be smart enough to keep her own money safely away from their husbands as there is no gurantee that men will not dump their wives and run away with the mistresses.

financialfreedom said...

The man should wear the pants and run the household like a business.

I think it is not just the financial aspects of the household that should be run like a business. Other aspects should include things like visioning, goals and stuff.

If we pour in so much effort to do such stuff at work, surely our family also deserves such direction and focus like a business other than just the financial aspects.

PanzerGrenadier said...

Hi LP

I agree with you totally.

As a CPA, I realised the most benefit I got out of my Accounting qualification was a good career but also the ability to analyse my own financial performance from a balance sheet (net worth) perspective as well as a income and expenditure (or cash flow) perspective.

Thus, I've been measuring my own income earned, expenses spent as well as net worth built up.

It has also given me more clarity on how much I need to save in order to achieve my goal of $1m in net investible worth in 6+ years' time.

Be well and prosper.

Lau said...

Personally feel the hype for the perfect wedding is over rated. Probably played up by all the commercials. Then the ladies start dreaming of wanting the same thing.

After being thrifty to save up your $50k challenge, is it worth to blow most if not all of it on a wedding? It is perfectly all right to spurge a little, but it is still important to do it within means. The "once in a lifetime" sales talk sometimes gets to people.

la papillion said...

Hi mw,

Wow, your accountings is way beyond me :)

la papillion said...

Hi Lau,

Thanks for your well-intentioned advice. Rest assured that I've no dreams of having a grand wedding. I budget it at 30k for everything, with the possibility of recovering 10-15k back for the banquet. The rest of the money will go into the housing issues.

la papillion said...

Hi bro8888,

Actually I agree. In fact, I think both husbands and wife should have their own personal accounts as well as a joint account for different purpose. Joint account for joint uses, while individual for personal use.

Men should also keep their personal stash (openly, i believe) just in case too. Not all women are vulnerable and defenceless.

la papillion said...

FF,

Well, I believe that there must be a person in the household who makes the decisions, though it need not be a man. Some pple are good at the big picture, some are good at the details, so to each his own :)

la papillion said...

Hi PG,

Thought of getting such certification too, for self learning purpose. But the cost of it is so exorbitant, I think I'll do fine doing my own self study.

But i agree with you. There are usually fringe benefits if one just connect the dots :)

Anonymous said...

Hi LP,

Thanks for sharing ... and then there is also "corporate social responsibility" for company, which is applicable for "individual as pte co." too.

There is one thing I was thinking lately. The "reward" system u mentioned & heavy focus on "end result" (vs others like "intention" & "process").

And what is this "end result" (usually is material possessions/money) we are focusing on, as well as "time frame".

Think "legacy" you want to leave behind for your offsprings - stretches your timeframe isn't it?

Cheers!

HH

la papillion said...

Hi HH,

Haven't reached that kind of maturity yet to think of legacy :) I guess time and experience will lead me to it :)

Anonymous said...

Hi LP,

Neither have I. Nothing to do with age I think. :)

I used to ask students to think what they would write if they were to write their own eulogy.

I have not come around to think abt my own. haha..

Cheers!
HH