Published September 1, 2005

As a part of deciding how to pursue your financial goals, you should take a look at where you stand right now. You do this by adding your assets in one column and your liabilities in another column. Then you subtract your liabilities from your assets to find your net worth.

Net worth doesn’t measure cash flow, but there’s a clear relationship between how you spend your money and what your financial picture looks like. If your assets outweigh your liabilities, you have a positive net worth. If your liabilities are larger, you have a negative net worth. Most experts say your first goal should be to get in the “black” or a positive net worth.

In the old days, accountants listed assets on their ledger sheets in black ink and liabilities in red ink. If you had a positive net worth, you were in the “black.” Otherwise, you were in the “red,” which is not a good place to be.
The worksheet we have described above is also called a “balance sheet.” Individuals have them as well as businesses.

Assets are usually divided into categories. Individuals may divide their assets into cash reserves, investment, personal assets and real estate.

Cash reserves would include cash or the equivalent of cash that you can convert to cash in a short time to cover an emergency. They include checking, savings and money market accounts. You would also include CDs, Treasury bills, savings bonds, and cash value in your life insurance policies.

Investment accounts would include assets like stocks, bonds and mutual funds. These assets may produce income and also provide growth. Long term investment accounts would include all of your retirement accounts like annuities, IRAs and employer sponsored plans.

Personal assets are your possessions. Some assets like antiques, collections and art may appreciate or increase in value. Other personal assets, like cars, boats and home furnishings, may depreciate or decrease in value over time.

Real estate is a special asset because you can use it yourself, rent it and eventually sell it for a profit.

Liabilities are also divided into categories. Usually they are divided into short and long term debts.
Short term debts include credit card charges, installment and personal loans. Income and real estate taxes fall into this category as well as insurance premiums.
Long-term debts are mortgages and other loans that you repay over several years.
Every financial plan starts with a snapshot of your financial picture-your net worth. It should be updated regularly. It may come in handy for many financial situations.
Mortgage lenders require a statement of your assets and liabilities as part of the loan process.

College financial aid is based partly on your net worth. You will have to report it when you apply for college aid.

Loan and line-of-credit applications usually require a net worth statement.
Making some investments often requires a net worth statement to determine the suitability of the investment for the investor.

The most important reason to calculate your net worth is to determine if your are heading in the right financial direction. If your net worth is not growing from year-to-year, you are not making progress.

Some day the earnings from your assets may replace your salary or earned income. The more assets you have, the more potential income you may have at retirement. However, it is possible to be asset rich and cash poor. This happens when assets don’t generate income without selling them. This problem poses some interesting questions for families with this type of balance sheet.

A review of your net worth statement is also a good place to start when analyzing your spending patterns. If you have more debts than assets, you may have a serious problem with spending. Being in the “red” can create significant stress on a marriage and on the quality of your family life. If you don’t know your net worth, good or bad, you may be ignoring a potential problem or a wonderful opportunity to pat yourself on the back.
Having a positive net worth doesn’t just happen. It comes from spending less than you earn and having the discipline to invest the difference.

Tom Mills & Jonathan Gates are partners in Mills, Parker & Gates LLC, a registered investment advisor. If you have questions or topics, you may call or write Tom or Jon at 809 Broadway Sonoma CA 95476 (707) 996-7800, FAX (707) 938-8668 or e-mail
suntrm@aol.com.