In the previous post, we had discussed Financial Statements and how to evaluate them. If you have not read that post, you can check it out here.
In this post, we are going to see the similarities between a person and a company as an entity from a financial perspective. Check out the post mentioned above to have a background reference for the discussion.
If you have read my blog post on Financial statements, you would know that there are three major types of financial statements for any company, namely the Profit and Loss statement, the Cash Flow statement, and the Balance sheet.
To summarise, the Profit and Loss statement gives an overview of a company’s profit or loss during that period, the period might be one month, one quarter, or one year. The cash flow statement traces the flow of cash, that is, where all the cash is coming from and where it is going. Then, the Balance sheet is the record of all the assets and liabilities of the entity.
If you take a minute to think, these statements collectively are enough to define the overall health of any business. This concept of these statements to determine financial health, forecast the financial future of the company, and make investing decisions can also be applied to an individual.
How do you wonder? Follow ahead to understand better.
Drawing Parallels between an Individual and a Company
Interesting parallels can be drawn between Individuals and a company if observed properly. Read ahead to discover.
Starting with the Profit and Loss statement. Individuals can also have a Profit and Loss statement, which can reflect the quality of the decisions they make in life, that is, good or bad decisions.
For example, suppose an individual buys an automobile that is way out of his/her reach, then he/she will have to strain their pockets to cover the maintenance and the fuel expenses of their vehicle. This can lead to losses in the future due to missed opportunities where this money could have been used, also known as opportunity cost. Or if the individual makes an investment decision in a land that doesn’t give returns as expected.
Next, the cash flow statement. Individuals can also have a cash flow statement, which can reflect how they are managing their cash flow, that is, whether they spending the right amount on necessities and wants and saving enough. This can be monitored through budgeting and then used as a measure to reduce unproductive spending. For example, if a person budgets that he/she will spend 30-40% of their income on necessities like housing, food, office commute, and necessary clothing, and spend 20% on recreation, and save the rest of the amount.
He/she can then analyze where they have overshot the budget and determine the root cause of the same, and then take precautionary steps to ensure it doesn’t repeat in the future. This can also help you reduce unconscious spending.
Next, the Balance sheet. Individuals can also have a Balance sheet, which can reflect the assets and liabilities they carry, such as financial instruments, real estate, mortgages, loans, etc. This helps the individual determine their solvency. That is, if they are in too much debt or do they have sufficient assets to cover up in case anything goes wrong.
The above can be summarised in the table below.
| Company | Individual | |
| Profit and Loss Statement | Gives the aggregate profit and loss in a given period of time | can help to understand the gains/losses from assets or income progression |
| Cashflow Statement | Gives the cashinflow and outflow | can help assess and optimize the budget created by an individual |
| Balance Sheet | Shows how the assets and liabilities compare to each other for a company | can help assess whether they are on the right track and evaluate the insolvency risk |
Developing Frameworks
Frameworks can be developed based on these statements. Let’s take an example of an individual who earns INR 1 Lakh per month.
Suppose this individual Plans to invest 20% of his/her income in assets, with 40% of that in income-generating assets and the rest in growth assets. Then 40% of his/her income on necessities and the rest 20% on leisure/luxury/experiences.
Now, if the individual wants to enforce the above, he/she can make the three statements as mentioned previously. First, let’s start with the Profit and Loss statement. The individual can create a profit and loss statement to check if the investments they are making are generating satisfactory gains over any selected period, whether monthly, quarterly, or yearly. It can also be used to compare whether the annual increment of salary is sufficient or is leading to losses as compared to inflation.
The cash flow statement can help them assess if they are spending cash according to the budget or exceeding it. They can also analyse whether they can optimize the cash outflow to increase other parts of the budget to enhance their lifestyle. For example, suppose the individual realises that the 40% allocated for needs is more than sufficient then he/she can increase the leisure or investing section whichever they want according to their need.
Next, the balance sheet can help people access people if the assets they have are sufficient for their present and future goals. They can also track if they are meeting their plans and if they are at risk of insolvency due to high debt.
I personally believe that if people start applying this framework in their lives, they can maintain better financial health in their life and live a fulfilled life. Personally i also have my cashflow, Profit and Loss statement, and balance sheet.
This is all for this post, comment your thoughts below in the comments section. Don’t forget to follow my Facebook page and Instagram pages for regular updates. See you all in the next post, till then keep learning.