Millennials Guide to Building a Solid Financial Foundation
Building a solid financial foundation is critical to supporting your needs and your financial success. Having a solid foundation in place allows you to reach your financial goals, avoid common financial pitfalls, and strategically manage unexpected circumstances. Below we highlight a few key components to help you lay the cornerstones of a solid financial foundation for long term success.
Understand your cash flow
A good place to start building a solid financial foundation is with your cash flow statement, which is a representation of your net monthly cash flow. Cash flow refers to the difference between the money you have coming in and money going out. In order to calculate your cash flow you need to know your income and expenses in a given period and compare them.
Money flows in as income and back out as expenses. Your flow can be negative or positive. A positive cash flow indicates that liquid assets are increasing, while a negative cash flow means more money is being spent than is coming in. To calculate your monthly cash flow, add up your net income then calculate your average monthly expenses. Subtract your monthly expense figure from your monthly net income to determine your leftover cash supply.
Cash Flow= Money In - Money Out
It’s essential to know where your money is coming from, and where it is going. Knowing your cash flow can help you determine whether you're using your income responsibly, or if your spending is excessive.
Develop a Budget
A budget is the cornerstone of a solid financial foundation. It allows you to manage your money successfully and saves you from future financial hardship. Once you have an understanding of your cash flow you can then easily begin the process of developing a budget. The difference between a budget and your cash flow statement is that a budget projects how you expect to allocate the cash flow and records how the cash flow was actually spent at the end of the month.
Manage Debt Strategically
An important part of your financial foundation is how you manage your debt. Not all debt is created equal. There is a difference between good debt and bad debt. Good debt does not have a negative impact on your credit score. Good debt allows you to leverage your money to gain an asset. Education loans and home loans are two things that generally qualify as good debt. Bad debt can hurt your credit score, making it difficult to borrow in the future. Strategic debt management is prioritizing debt repayment by interest rate. In other words, you make extra payments to pay off bad debt, before paying off good debt or you can pay off debt in order of smallest to largest (Debt Snowball).