Value Your Finances Like Valuing Assets: Putting Valuation in a Personal Financial Context

by elmads

Introduction

Most people, if not all, want a comfortable financial life. Comfort in the sense that our finances have the capability to cover our necessities of life and still have the excess cash that can be used for leisure.

The question here is: what is the comfort number? And is it usually based on salary? Is it based on net worth? Or salary-to-cost of living? Plus, comes a statement such as “I want to be rich”, which puts in a lot of questions like, What do you mean by saying “rich”?

And usually, people answer these questions by comparing their financial status to others or the broader population. Usually this is done by benchmarking oneself to others via their salary; while this is the common way, it is not an accurate assessment of one’s wealth.

Even individuals who have a six-figure monthly income in USD live paycheck-to-paycheck. A salary doesn’t necessarily mean a high level of wealth, but what it does signal is strong financial stability to cover our necessities of life and have a lot more to spend on discretionary expenses.

Conversely, net worth is way different from a salary. It reflects one’s financial knowledge, skills, and capabilities to build wealth. It is a life skill that shows a person’s priorities in life. Their financial discipline, focus, and habits are being reflected in their net worth.

You can have a high salary with a negative net worth or have an average national salary and still have an above average national net worth. Or you can have both a high salary and a high net worth.

The knowledge and skills that are required for a certain salary, the industry (currently in the UK, finance and tech are the two highest paying industries), the supply and demand for a certain job (highly salaried individuals have certain knowledge and skills that only a few people have), the same can be said for business owners and self-employed individuals. On top of that, what you do next with your salary or cash flow after you’ve received it will dictate your net worth.

Net worth is your assets minus your liabilities. It’s certainly an interesting concept to gauge how well we are doing financially. But when we calculate our net worth, we’re looking at the present time. What if we want to look into the future? How would we somehow see how well we would be doing?

What I thought of was this. Why not investigate our personal financial cash flows into the future and discount them to our present day? Or,? in short, let’s see our personal financial intrinsic value rooted on the financial habits that we’ve built today.

Instead of doing a discounted cash flow of a business or asset, we’ll be doing it to ourselves. Finding the intrinsic value of our cash flows, or, as I would think of it, our financial habits, dictates our own financial intrinsic value.

It's assessing and analysing ourselves, like how we analyse businesses. It begs the question: if you treat your personal financial habits, strategies, and capabilities as those of a business, would you be confident enough to invest money in yourself?

Assumptions for Getting Our Personal Financial Intrinsic Value

The approach we’re taking here is no different from how we get the discounted cash flow of businesses, where we start by knowing how a company makes money, then subtracting all the costs so that we can arrive at the free cash flow of the company.

Below are two images in a compared view, where it shows the similarities of a business' income statement and an individual's salary statement.

Additionally, below is an infographic how we can arrive and find a company's free cash flow.

Blog links regarding the previous infographics.

?? https://elmads.com/?p=2536 - The Income Statement

?? https://elmads.com/?p=2845 - The Cash Flow Statement

?? https://elmads.com/?p=2901 - Free Cash Flow

Though what I showed you is for getting free cash flow specifically for companies, we can also use the same concept for ourselves to get our personal financial cash flow.

Where it starts with your

• Gross pay Taxes Other deductions
• Net pay Essential spending and maintenance expenses
• Free cash flow or the excess cash left that can be used for either: Paying our outstanding debts Discretionary spending. The non-essentials. Investments and financial projects

Because we’re talking about personal finance, where debts are usually not for cash generation purposes or investments, we need to assume that we will always focus on our cash flow to pay our debt as soon as possible.

Therefore, what is left is savings for personal financial goals for the future and for our discretionary spending.

Here are my assumptions:

• The average salary in the UK as of 2023 is ￡26,000.
• The average savings rate in the UK as of 2023 is around 8%.
• I’ll assume that Marcus (made up name for example purposes) consistently saves 7.38% (lower than the average) of that ￡26,000 average UK salary, which would give us ￡1,920 yearly savings or ￡160 monthly savings.
• I'll include the discretionary spending in our assumption as this portion of finance doesn't automatically mean money to be spent within a month or a year, but money that can be saved now so as to be spent within 3 years (short-term financial goals).

Below is a sample snapshot of what I’ve written above, including the blog links I shared, which would give you substantial information regarding how to organise your finances like a financial mutant.

Marcus' simple personal financial statement from gross pay to his savings. Computed in a year.

• Gross pay (Year 1): ￡35,616 Taxes Other deductions, e.g., state pension, private pension, and health services
• Net pay (Year 1): ￡26,000 Essential spending plus maintenance expenses (￡20,000)
• Free Cash Flow (Year 1): ￡1,920 Outstanding debts paid + interest payments (￡1,580)
• Free Cash Flow Less Debt (Year 1): ￡4,420 Discretionary spending: ￡2,500 Savings (￡1,920)

Compare this one with how we arrive into a company's free cash flow, you'll notice that It is identical, if not the same, isn’t it? Because the concepts of cash flows are universal, regardless whether we are talking about personal finance, corporate finance, or public finance. What’s important is to grasp its fundamental ideas.

To do all of these, we must have the fundamental concepts of budgeting, understanding our cash inflow and outflow (data on how we save, spend, and invest), self-awareness, and humility.

You can't assess yourself as objectively as possible if you lack humility, or, in a harsher way, if you're full of yourself. Extreme ego is a barrier to growth as it blinds people to thinking that they know everything in this world already, including their real selves, when that is not even the case.

?? https://elmads.com/?p=1444 -Financial Mutant Level of Managing Money – Your own Income Statement

?? https://elmads.com/?p=1483 - Financial Mutant Level of Managing Money – Your own Cash Flow

To Be Continued