As we embark on our financial journey, let’s start first with understanding where we are right now. It’s great if we already have some financial goals and know what we want to achieve but unless we check the map and figure out our current location, we wouldn’t know how to reach our destination.
I think our generation (say hi, fellow millennials) lives in a different reality than our parents and grandparents. Though what I’m going to talk about applies to them as well, it’s even more important to us. We live in a world where in order to be successful each of us has to treat ourselves, even our personal lives, as a business venture. You may be quite startled by this realization. We have heard multiple times at school, at work, on YouTube, and on TV about our personal brand, and how we have to work hard and think about what we do and say, and what image we present to the outside world.
Let’s take this one step further. We should also treat our personal finances in a way that any business would. Those familiar with accounting practices know that businesses usually prepare four types of financial statements. We are not interested in all four of them. Only two are applicable in our case: Statement of Financial Position (formerly known as Balance Sheet) and Cashflow Statement. On a personal level, Statement of Comprehensive Income translates into a Net Worth Statement. Today, we are going to talk about net worth statement, and we will talk more about cash flow statement when we get to budgeting.
The net worth statement is a snapshot of our finances at any given time (or our current location from where we start our financial journey). It’s a very easy concept to grasp.
Net Worth = Assets - Liabilities
What this means is if we take the value of all our assets and subtract the value of our liabilities, we will know exactly how much we are worth.
When we talk about assets, we mean everything we have that has some monetary value. This includes money on our chequing and savings accounts, our existing investments, our pension from our employer, employee share ownership plans, and market value of our property or properties.
Liabilities mean any money we owe somebody. This can be outstanding balances on credit cards and lines of credit, mortgage, car loans, any money we may have borrowed from friends or relatives, and so on.
Why is our net worth important? Very often people only think in terms of their assets and disregard liabilities. They can think that they have $100K in their savings account and a $1M home, and forget that they have a $500K mortgage on it, a line of credit with an outstanding balance of $100K and some credit card debt for $50K. So, in this case, if they think they are worth $1.1M, this would be wrong because they did not account their liabilities. And the total amount of liabilities is $650K. Therefore, their net worth is:
Calculating net worth may sound more daunting than it actually is because a lot of this information is already available to us if we go to accounts summary page in our online banking or our mobile banking app on our phones.
However, calculating our net worth just once is not enough. We should do it periodically and then compare the numbers then and now. When financial advisors work with their clients, they calculate the clients’ net worth at least once a year. However, I suggest doing it more frequently, preferably once a month in the beginning so that you could see how you are tracking. I get paid biweekly, and when I started doing this for myself, I calculated my net worth biweekly too, and it didn’t take long, maybe five or ten minutes at the most. But it gave me a good understanding of whether I was moving in the right direction.