Debits, credits, liabilities, equity — there are so many terms you need to understand when taking control of your finances. Where do you even start? Accounting, or the practice of maintaining your financial accounts, is not as complicated as it may seem. This overview will help you understand all the pieces that make up the personal accounting puzzle, as well as how you can use this knowledge to improve your finances.
Terms You Should Know
The terminology below will help you understand the different aspects of your personal finances. For more important terms you should know, take a look at these financial ABCs.
Assets: Anything of tangible value that can be converted into cash. There are two types of assets. Liquid assets are things that can be converted into cash quickly like the money in your bank account. Illiquid assets, like a house or antiques, cannot be converted quickly without substantial loss in value.
Liabilities: Debts or obligations that are owed. These incude, but are not limited to credit card balances, auto loans and other debts.
Net Worth: The amount by which your assets (what you own) exceeds your liabilities (what you owe). The formula to calculate your net worth: Assets – Liabilities = Net Worth. Your net worth is a good gauge for your personal financial health.
APR: Annual percentage rate, or the yearly cost of your credit (including interest, originations fees, etc.) expressed as a percentage.
Line of Credit: An amount of credit extended to a borrower on a rolling basis. There is a maximum amount, but less can be borrowed. A credit card is an example of a line of credit.
Instalment Loan: A long-term loan (typically six months or more) that is repaid over time with a fixed borrowed amount. For example, a mortgage is a type of instalment loan.
Diversification: The practice of spreading your investments out into different areas as a way to prevent extreme swings in their value. It’s a way to help you balance the risk and reward of investing.
Credit Score: A generated score based on several factors that determines your creditworthiness and what you will qualify for. These factors include account balances, debt payment history, total credit available, loan history, etc.
Fact: Over half of UK households use a budget to maintain their personal finances.1
Set Up a Budget
Once you understand the many components that make up your personal finances, it’s time to take control of them! The best way to do that is by building out your budget. There are many different methods to budgeting, so find the one that works best for you and accounts for all aspects of your finances (income, debts, savings, basic needs, etc.). While your budgeting strategy may change over time to accommodate the ebb and flow of life, the items below are things you will always need to consider. Collect this information to start your journey to better budgeting.
What you’ll need:
- Monthly rent/mortgage
- Other monthly bills (mobile bill, streaming services, gym memberships, etc.)
- Credit card bills
- Personal loans
- Car loans
Tip: If you aren’t confident that you’re accounting for all of your expenditures, look over your checking account statements for the last three months to confirm if you overlooked a regular expense. You can also use this to help budget for average grocery spending, entertainment, etc.
Debt Payoff Methods
One of the easiest ways to improve your credit score and net worth is by eliminating your debts. It also makes more room to save and improves your financial stability. There are two popular strategies for paying off debt that you’ve accumulated over credit cards and personal loans:
Debt Snowball: This strategy has you paying off your smallest balances first to help you build better payoff habits and help build momentum towards the larger debts you need to tackle.
- Pro: Each time you pay off an account, you’ll have fewer overall payments to make and feel accomplished.
- Con: By prioritising loan balance, interest rates are neglected, and you could end up paying more in the end.
Use this calculator to utilise the snowball method with your current debt.
Debt Avalanche: This method prioritises your debt by the highest interest rate. This way, you will end up paying the least amount of fees possible during your payoff schedule.
- Pro: The avalanche method saves you time and money by minimising the amount of fees you’ll end up paying out in the end.
- Con: If you struggle to maintain the motivation to see the plan through, you won’t finish paying off the debt, meaning you don’t save time or money compared to the snowball method.
Use this calculator to utilise the avalanche method with your current debt.
Each small step you take now to improve your personal finances will help alleviate stress down the road and provide more opportunities later on. From paying off debts to building up emergency savings, there are a lot of ways you can improve your financial health — choose what works well for you and your budget!
1The Money Advice Service. (n.d.). Beginner’s guide to managing your money. Retrieved 31 August 2017, from https://www.moneyadviceservice.org.uk/en/articles/beginners-guide-to-managing-your-money
The information in this article is provided for education and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.