In accounting, to understand the financial position of a business, we look at the Balance sheet which includes the assets, liabilities and equity accounts. Do you know, the balance sheet concept does not only apply to businesses? Because for personal finances, it is widely used to calculate one’s net worth.
Why Understanding Your Personal Balance Sheet is Important?
If you are planning to build your wealth to achieve financial freedom, it make sense to know your current position first. A Balance Sheet can let you know exactly how wealthy you are.
Creating your personal balance sheet is really easy. Contrary to what many think, you do not need to have a degree in accounting to understand this concept, you just need to know its basic components: assets, liabilities, equity.
Assets (What you have)
- An asset is something that you own which has monetary value. In other words – something you have, you bought or acquired. If you can also sell it, it is an asset. (Lahat ng meron ka, kayamanan, ari-arian)
- Common assets include cash, savings accounts, investments, real estate properties, vehicle, jewelries and subscriptions.
- Clothes, phone or furniture and other small things can be included as assets depending on how precise you want to present your balance sheet.
Liabilities (What you owe)
- A liability is anything that you owe or anything you need to eventually pay back. (Utang)
- It is a debt or payable to an individual, business or institution such as a bank.
- Common examples of liabilities are credit card bills, personal loans, car loans, home mortgages or any unpaid bills.
Equity (What you Really have)
- Equity is your net worth. It is the difference between your total assets and total liabilities.
- This is the most accurate measure of your wealth.
- This includes your retained income.
- You only need to use basic math to compute your equity or net worth : ASSETS minus LIABILITIES equals EQUITY (Net Worth)
Let’s take a look at Juan’s situation. Juan, 30, earns monthly income of P45k. He has he already has investments and he got himself a brand new car, but how wealthy is Juan?
Uh-oh, Juan got a negative net worth. He has more liabilities than assets. Even if he sold all his assets to pay his debts, he will still come red. To turn things around, Juan needs to make serious efforts in planning his finances such as reducing his spending and paying-off his credit card debt balances. If I am to advise Juan, he should use his investments to pay his credit card debts which piles him with interests monthly. Also, with his income of P45k, he needs to properly budget his money and consistently become conservative in spending until he turns his net worth to positive.
Compute for your Net Worth!
Now that you know how easy it is to prepare your personal balance sheet, why don’t you try to compute your own net worth? It’s fairly easy right? Knowing your net worth is the first step in achieving financial freedom.
When your net worth is negative number, then you are not managing your financial resources properly. It is not a short-term pursuit to make substantial increases in your net worth, but being aware of your current situation is the first step to take. Next is to have effort and commitment for a positive change each month.
If you are just starting at work it is reasonable to have ZERO net worth, because it make sense of course that zero is the starting point. Just getting started in your career is the best time to start building your net worth. If you grow your net worth to positive, you can ride out any financial storm you may face.
Here are simple steps you can make right away to increase your net worth:
1. Save first before spending
When you receive your income, allot a portion to savings before spending. If you have debt, allot a portion to pay off your debts before spending. Then you can splurge on whatever’s left for you to spend. With this, you are developing for yourself the habit to save.
2. Keep track of your expenses
Obviously, if you spend more than what you earn, you will lose money and end up a with negative net worth. Tracking your spending in a budget persistently every month can be helpful. Then have the decision to cut-off unnecessary expenditures such as your weekly shopping, dining out every night, or monthly watching of movies in cinemas.
3. Get out of bad debt
There are good debts and bad debts. Good debt is basically an investment which can bring you potential income or value which appreciates while a bad debt is the other way around. An example of a bad debt is credit card purchase for your wants. Your monthly interest payments may not seem like much, but in aggregate they can be overwhelming. Imagine, you could have used that money you pay on interests to buy more assets that generate income. Paying-off your credit card can make a huge difference in your financial situation.
It is not enough that you save, but you should invest your hard-earned money and take advantage of passive income investments can provide to you. Investment in stocks, bonds or mutual funds can make your money grow. You don’t need to have hundred thousands of capital to start investing. You only need a small amount of your earnings to tap the stocks and bonds market. You can contact us if you want to get started in investing in mutual funds.
Get our FREE Balance Sheet template!
I’d like to help you get started. Contact us and we will give you our free Balance Sheet Statement template. Just include in your message about FREE balance sheet template. The template has the list and classification of the assets and liabilities so you will just key in the amounts and it will auto-calculate your net worth.