This post is part of the textbook personal finance series which covers basic personal finance skills by going through an actual textbook, chapter-by-chapter. Check out the intro post for more information.
Last week we talked about creating a system of personal finance records (which has the added benefit of helping you get organized to do your taxes). This week, we’re going to start part one of two on creating personal financial statements. We begin with creating a personal balance sheet.
A personal balance sheet is one of the two tools that help us create our personal financial plan. The second sheet, which we’ll be talking about next week, is a cash flow statement.
Essentially, a personal balance sheet (which is sometimes also called a net worth statement or statement of financial position) reports what you own and what you owe.
What You Own – What You Owe = Net Worth
I’ve created a free Personal Balance Sheet spreadsheet you can download and use as you go along. It’s based on an approximation of the public—you may not have 2 cars or 2 car loans, feel free to delete any unnecessary lines or leave them blank. There is also a site called NetworthIQ which helps you create and maintain a personal balance sheet. There will be more details on it after the steps for creating your personal balance sheet.
Step 1: List Everything of Value
This is a list of what you own and it includes any assets that have value. Here are four different kinds of assets you may have:
- Liquid assets – includes cash and things that can be quickly converted to cash. Checking, savings, CDs, and money market accounts are all liquid assets.
- Real estate – includes homes, condominiums, vacation property, and commercial property.
- Personal possessions – includes cars, electronics, any personal possessions which have a monetary value. When appraising the value of personal possessions, don’t write down what you paid for them but rather the value they’d likely have in retail. A 5-year-old computer that cost you $1000 may only be worth $200 now.
- Investment assets – includes all investments. These are not liquid assets. Investments made in retirement or college saving accounts may have penalties if you try to remove funds. Moreover, because you’re investing for the long-haul, the shares may have lost value.
Step 2: List All Amounts Owed
Liabilities are amounts owed to others but not amounts not yet owed. Your mortgage is a liability. Your rent is not unless it’s overdue. There are two categories most liabilities fall into:
- Current liabilities – these are debts that need to be paid off in a short time-frame, often a year or less. They may be medical bills you’re paying in installments, credit card balances you’re getting rid of (and ones you’re not), etc.
- Long-term liabilities – these are debts which you won’t have to pay off for years (not that you can’t speed up paying them off as part of your financial plan). They generally include mortgages, auto loans, and student loans.
Why put the liabilities into these two categories? If you’re planning to pay off your debts faster than the lender requires, splitting them up into these two groups puts a focus on the debt you can knock out first.
Step 3: Calculate Your Net Worth
Add up each column. Then subtract your liabilities from your assets. This is your net worth. It is the amount that you would have if you liquidated all your asserts and paid the money toward your liabilities.
Of course a personal balance sheet doesn’t necessarily reflect your financial day-to-day life. For example, you may have a positive net worth because you own more of your house than you owe, but selling your house requires finding another place to live and purchasing it or paying rent. That’s why next week will be about creating a cash flow statement.
What your net worth does tell you is your current financial position. The balance sheet shows you places you can focus on when creating financial goals—you may decide to beef up your emergency fund or realize you have enough to pay off your credit cards right now.
Online Alternative – NetworthIQ
If you’d like to keep track of your net worth online, you can sign up for NetworthIQ, a free site which provides slots for you to enter values of assets and liabilities and them computes and charts your progress for you. You’ll see charts it generates on some personal finance blogs.
The advantages of NetworthIQ are easy access, automatic graphing, and the ability to share your progress with others (though on the Account Options page you can also opt to keep your profile private). It doesn’t ask for any identifying information and its system is very easy to use.
Have you calculated your net worth? Was it inspiring or demotivating?