Last week, I introduced you to the idea of a “position audit.”

Using this strategy is as simple as taking a hard look at each of your investments and deciding if they still deserve a place in your portfolio.

Yet doing so regularly – once a month, once a quarter, or even once a year, depending on your investment approach and portfolio size – can dramatically improve your results.

That’s because a position audit forces you to be objective and address small mistakes in your portfolio before they become serious problems.

I believe a similar strategy – a periodic “personal financial statement audit,” if you will – can offer the same kinds of benefits for your overall financial situation.

The first step is to review your cash flow statement – or create one if you haven’t already.

That involves comparing your monthly “net income” – how much money you bring home after taxes – with your monthly expenses. I explained how to do so in detail in a Money Talks essay last fall.

The goal of this step is to ensure that you have a healthy, positive cash flow that grows over time. In other words, your net income exceeds your expenses.

This idea is critical. You’ll never reach your long-term financial goals if you don’t consistently spend less money than you earn each month.

So, if that isn’t the case – or your cash flow simply isn’t as positive as you’d like – you’ll want to correct that before you move on to the next step.

There are three primary ways to do this. You can earn more money (i.e., increase your monthly net income), spend less of the money you already earn (decrease your monthly expenses), or do some combination of the two.

The easiest place to start is by reviewing your “discretionary” expenses. If you’re like many folks, you’ll probably find you’re spending money on at least a few luxuries and unnecessary items that you don’t actually enjoy that much.

Next, you’ll want to review your fixed or “non-discretionary” spending. There are often relatively painless ways to reduce these expenses as well.

Finally, if reducing your expenses isn’t sufficient to improve your cash flow, you may need to generate more income by looking for a better-paying job, taking on some part-time work, or starting a “side hustle.”

Once your cash flow statement is in order, you can move on to Step 2.

The second step is reviewing your personal balance sheet (or creating one if this is your first time).

Your balance sheet is similar to your cash flow statement. Only instead of comparing your income versus your expenses, it compares your assets (what you own) versus your liabilities (what you owe).

Assets generally fall into one of three categories: 

1. Cash and cash equivalents: These include cash and assets that can be quickly and easily sold for cash without losing value or incurring significant costs, such as checking, savings, and money market account balances, short-term Treasury bills, life insurance (cash value), etc.
2. Property and tangible assets: These include things like your home and most real estate, furniture, vehicles, jewelry, clothing, collectibles, etc.
3. Investments: These include financial assets like stocks, mutual funds, exchange-traded funds (ETFs), etc.

Liabilities include anything you owe to lenders or creditors, such as mortgages, home equity loans, auto loans, student loans, personal loans, unpaid bills, etc.

To calculate your balance sheet, you’ll simply add up the current market value of all of your assets, add up the current value of your liabilities, and then subtract your total liabilities from your total assets.

The remainder is your “net worth.” And again, the goal here is to have a healthy, positive figure that grows over time. 

Unfortunately, if you’re like many folks, that may not be the case. In fact, if you have a significant amount of debt like I used to, you may be surprised to find your net worth is quite low (or even negative) today.

Like before, there are three primary ways to improve your net worth. You can grow your assets (direct your cash flow into investments that are likely to appreciate), reduce your liabilities (direct your cash flow into paying down debt), or do some combination of both.

The best place to start is almost always to pay down your debts.

The reason is simple: Investing to increase your assets always carries some amount of risk, whereas paying down non-productive debt provides a guaranteed return.

For example, if you carry credit card debt with a 17% interest rate, paying that debt off is the equivalent of earning 17% on that money. That’s nearly double the long-term average return of the U.S. stock market.

(You can learn more about paying off debt – including how my family and I solved our debt problems – here and here.)

Once your liabilities are under control, you can then focus on directing your cash flow into investments that can significantly grow your net worth over time.

Calculating your personal cash flow statement and balance sheet does require a little time and effort upfront. But once you’ve done so, reviewing these documents periodically – such as once a year or whenever your financial circumstances change – is a quick and easy way to help ensure you stay on track to meet your financial goals.

In addition to the “position audit” I shared last week, I hope you’ll give this strategy a try, too.