“Pay off student loans”. “Open a Roth IRA.” “Save for a down payment on a house.” “Save for a wedding.” “Should I rent or buy?” “How much should I save for my kid’s college education?”
There are many things out there commanding our financial attention. For many, all the competing priorities can lead to paralysis, causing you to give up altogether on the idea of getting your finances in order.
If you are going to get directions somewhere, your GPS needs to know your current location. Without a current location, you can't get directions to where you want to go. Figure out where you currently stand financially by creating two personal financial documents, a net worth statement and a personal income statement. Before you roll your eyes, or say that you aren't good with numbers, let me reassure you that it's easy to do. The exercise will open your eyes and give you clarity on your current situation.
A net worth statement simply looks at what you owe (liabilities) versus what you own (assets). Some of you may be living in the dark on your current financial situation, and the thought of turning on the light scares you. It’s time to get real with yourself. No more living in the dark about your finances. Dig up all your student loan statements, auto loan statements, credit card statements, mortgage statements and statements of any other loans you may have. Make sure you find EVERY single debt you have. Add up the current balance on all your debts and that number represents your total liabilities.
Now, on to the assets. Maybe you are a recent college grad with $50,000 in student loans and you are a feeling like a failure because you don’t have any assets to speak of. If you find yourself in this situation, don’t despair. Many young people start out with few, if any, assets and quite a bit in debt. Make a list of all of your assets. Assets include money in your savings and checking accounts, money in investments, money in your retirement accounts, the value of your house, and any other thing you own. Keep the list of assets to the bigger ticket items (houses) that you may own. I’m sure that old college textbook or your iPhone has value, but let’s keep it simple and not include those “assets”. Add up to total value of everything you own and that number represents your total assets.
Take your total assets (if you have any assets) and subtract your total liabilities. Easy math, right? The number (positive or negative) represents your net worth. Once again, many people start off early in life with a negative net worth (don’t let a negative net worth get you down). Plenty of those people have gone on to be successful financially. Now that you have a clearer idea of your current financial situation, you can start developing a plan of attack. You should make it a practice to update your net worth statement at least once or twice a year. Doing so will help you track your financial progress.
A net worth statement is the same thing as a balance sheet. It is called a balance sheet because the balance sheet is typically broken down into two sides. Assets are on the left, while liabilities and equity are on the right. The two sides should balance out. An easy way to think of a balance sheet is the assets side shows what you own, while the liabilities side shows how you own it (either outright or through debt). Let's see you own a home worth $300,000 and you have a $250,000 mortgage remaining on the home. The $300,000 value of the home would be listed under assets. The $250,000 mortgage would be listed under liabilities, while the difference of $50,000 would represent your equity. (the amount of your home you, and not the bank, own). If you have a negative net worth, it means you have negative equity.
From purely a financial perspective, your net worth statement illustrates all you have to show for at a given point in time. A high paying job isn't a guarantee of success, just as a low paying job doesn't mean you can never be financially successful. If you were to get fired, or if technology made your job obsolete, your net worth statement is what you would have to show for. If you don't like your current financial position, as shown on your net worth statement, then it's time to turn to your cash flow statement for improvements.