In financial planning, you need to assess where you are now in financial terms, such as what do you own and what do you owe, how much money do you have and after making the various payments, how much money there is left.
When doing this, there are two types of personal financial statements come in handy; personal balance sheet and cash flow statement. These statements will help you to:
1. Provide information about your current financial position and a summary of your income and expenditure
2. Measure your progress in meeting your short-term, medium-term and long-term financial goals
3. Maintain information about your financial activities, such as investments and spending patterns
4. Provide data that you can use when preparing tax forms or applying for a bank loan.
Your personal balance sheet reports on what you own and what you owe.
Knowing your net worth
Your net worth is your total assets minus your total liabilities. You will have a positive net worth if you own more than what you owe. When this happens, congratulations! This means that you are in a healthy financial position.
However, having a high net worth does not guarantee that you will never face financial difficulties. So how is it possible for someone with a positive net worth to get into problems? Assets that are not liquid. When assets are not liquid (easily converted into cash) there could be potential problems looming ahead. Let us see how this is possible.
Say you have a house as your asset (where you live in), but you do not have cash in your wallet or bank account and you have already defaulted on your credit card payments.
The most pressing thing now is, you need money for your daily expenses.
Out of a job with no possible way of making one ringgit, you decide to sell your house for money to support your expenses. Here is the problem.
You cannot sell your house immediately to get money because the house, being an illiquid asset, is not easily sold and finding a buyer may take several months. It is also where you and maybe your family live. You really cannot sell your house unless you have somewhere else to go.
Being financially healthy means having a balanced portfolio of assets so that you will not be short of cash at any time. Thus, financial freedom will be within your grasp.
When you owe more than you own, you have a negative net worth. In this situation, you are unable to pay your debts when they are due because you do not have enough money or assets that can be easily converted into cash. You are actually in financial trouble and may be made a bankrupt.
Your net worth gives an idea of your financial position on a given date. Do not consider your non-cash items as cash as it may not be easily disposed.
Calculating your net worth
Step 1 – List the things of value that you own. These things can include
a) Cash and its equivalent, such as savings and fixed deposits accounts
b) Investments, such as stocks, bonds and unit trust funds
c) Retirement funds, such as EPF, personal retirement accounts
d) Properties like houses, apartment and land
e) Personal belongings that can be sold for money such as jewellery, gold bars, art and antiques
Step 2 – Total up your assets
Step 3 – List the things that you owe to others
Step 4 – Total up your liabilities
Step 5 – Assets minus liabilities such as loans, credit card balances, taxes owing, owed money, balance of instalment payments for consumer goods such as furniture and TV
If the number is positive, you should plan on how to increase your net worth. If it is negative, do not despair, because you can take actions to improve your position.
There are several ways you can increase your net worth. These include: Increasing your savings, cutting down your spending, reducing your debts, or selling some of your non-income generating assets/belongings.