Understanding the net worth of an individual form the foundation of the person's financial plan as it first and foremost provides a clear picture of what an individual's financial health is; this understanding then informs the kind of goals that are set and the priority of each goal in the individual's financial plan. Furthermore, budgeting ensures that the goals listed in the financial plan are adequately adhered to. Additional details on the importance of financial goals, net worth, and budget in financial planning have been detailed below.
- An individual's net worth is akin to a business's balance sheet; it is the value of an individual's assets minus their liabilities or debts. It gives a glimpse of how much a person "would have left over today if they had to cash everything out and pay all their financial obligations such as mortgage, student loans, and credit card debts."
- Understanding an individual's net worth value provides the foundation and the basis for the goals that would be set in the financial plans. It informs the next step of action for an individual and can be actual proof of a person's financial health.
- Understanding the net worth of an individual form the foundation of the person's financial plan as it first and foremost provides a clear picture of what an individual's financial health is.
- It then informs what exactly needs to be done to turn around a negative net worth as it shows exactly where the loopholes are and what is consuming the individual's money.
- An individual can also use their net worth as a measure of their financial growth and to see if their current financial plan is working or if they need to refocus or rechannel how they spend money.
- Additionally, individuals that have a good grasp of their net worth can refocus their financial emphasis beyond income as well as "wake the individual up to the downside of debt instead of just emphasizing assets."
- After understanding their net worth and getting a clear picture of their financial health, the next step is to set realistic goals based on the information garnered during the net worth phase combined with other relevant financial information; these financial goals can either consolidate the progress that has been made in building a positive net worth or reverse the trend of a negative net worth.
- Setting financial goals forces an individual to be disciplined and also forces them to prioritize. With an end goal in mind, it is easier for the individual to adjust their appetite for things that are not of immediate importance.
- These goals can either be short-term, mid-term, and long-term in nature and every financial plan has all three kinds of goals. The individual's current financial health will determine which bucket (the type of goal) is given the most priority per time.
- Examples of short-term goals include establishing a monthly budget, building an emergency fund, and paying off credit card debts, while examples of medium-term goals include getting life insurance, paying off student loans, and building towards the person's dreams. On the other hand, typical long-term goals involve thinking about retirement and child education.
- Financial goals also change as a person's life and financial plans change. As Investopedia puts it, individuals "probably won’t make perfect, linear progress toward achieving any of their goals, but the important thing is not to be perfect but to be consistent."
- An individual's cash flow is an important part of their finances and is an important tool to understand a person's financial health. Cash flow details "what’s coming in every month versus what’s going out." According to Lauren Zangardi Haynes, a financial planner, "Individuals might be shocked at how much money is slipping through the cracks each month."
- An easy way to ensure money is not slipping through the crack is through budgeting, as every dollar counts in a financial plan.
- Also, after identifying an individual's financial health and developing goals to improve it as detailed above, it is through proper budgeting that these goals can come to pass. Budgeting also ensures that the goals that have higher priority according to the current financial plan are captured in the monthly expenses as they ought to. For example, an individual looking to build their emergency fund know they have to put aside a substantial sum every month for the next 3-6 months to achieve this purpose.
- Budgeting also blocks leakages and ensures every cent is put into proper use. Budgeting also ensures that the money coming in is channeled towards the right financial goals as detailed in the financial plan.
- Having a budget also keeps an individual within the confines of what they earn, so they don't end up spending money they don't have. Simply put, budgeting can curb bad spending habits and make more funds available towards an individual's financial plan.