Table of Contents |
A balance sheet helps you organize what you own – assets – and what you owe – liabilities. Your assets less your liabilities equals your net worth:
As shown in the following table, you should list everything you own on the left side of the balance sheet.
As you are starting out on your financial journey, that may be a relatively short list.
Later in your life, the list may grow to be very long. Grouping assets into categories, as shown in the table, provides a more efficient summary of your assets.
Technology: Skill Tip |
| Monetary Assets | Market Value |
|---|---|
| Checking account(s) | |
| Savings account(s) | |
| Money market account(s) | |
| Certificates of deposit(s) (short-term) | |
| Other | |
| Total | |
| Investment Assets | Market Value |
| Mutual funds | |
| Exchange-traded funds | |
| Brokerage account(s) | |
| Stocks | |
| Bonds | |
| Rental real estate | |
| Cash value of insurance | |
| Certificates of deposit(s) (long-term) | |
| Total | |
| Retirement | Market Value |
| Employer plans | |
| IRA(s) / Roth IRA(s) | |
| Other | |
| Total | |
| Miscellaneous | Market Value |
| College savings accounts | |
| Hobby assets | |
| Other | |
| Total | |
| Total Assets | |
| Short-Term Liabilities | Amount |
| Personal loans | |
| Visa® | |
| MasterCard® | |
| Other credit card(s) | |
| Utilities | |
| Other | |
| Total | |
| Long-Term Liabilities | Amount |
| Mortgage | |
| Second mortgage | |
| Vehicle loan 1 | |
| Vehicle loan 2 | |
| Boat loan | |
| Student loan(s) | |
| Consumer loan(s) | |
| Installment loan(s) | |
| Other | |
| Total | |
| Total Liabilities | |
| Net Worth | Amount |
| Total assets | |
| Total liabilities | |
| Total Net Worth |
You may have noticed that the balance sheet is set up so that assets that you can sell quickly are at the top and the least sellable items are at the bottom.
Productivity: Skill Reflect |
Once you have listed everything you own, you must place a value on the assets. You almost always want to show the fair market value of the things you own. The fair market value is the price someone would realistically pay you to buy the asset. It is not the price you paid for something or the price you would pay someone else.
EXAMPLE
Let’s look at Tommy’s balance sheet. Tommy just graduated from college and is preparing his balance sheet. He has been working for about six months and recently purchased a used car using a loan from the bank. He has started saving in his employer’s retirement plan. Along with his other personal belongings, the assets section of Tommy’s balance sheet is shown in the table below.| Monetary Assets | Market Value |
|---|---|
| Checking account(s) | $272 |
| Savings account(s) | $1,321 |
| Total | $1,593 |
| Household Assets | Market Value |
| Tommy's car | $8,500 |
| Furniture | $1,200 |
| Electronics | $1,500 |
| Other personal belongings | $500 |
| Total | $11,700 |
| Retirement | Market Value |
| Employer plans | $934 |
| Total | $934 |
| Total Assets ($1,593 + $11,700 + $934) | $14,227 |
Now let’s jump to the other side of the balance sheet. Here is where you list all your liabilities – the debts that you owe to others – such as credit card debt that has not been paid and any loans on items such as cars, jet skis, houses, and student loans. Determining how much you owe is easy.
EXAMPLE
Let’s look at the liabilities section of Tommy’s balance sheet. We know that he recently purchased a used car using a car loan. Tommy also has some credit card debt that he generally pays off monthly, but at the current moment he does have a balance on his credit card. He also has some student loans. Tommy pays his bills on time, and his utility bills and rent are due at the start of next month. The following table shows the liabilities section of Tommy’s balance sheet.| Short-Term Liabilities | Amount |
|---|---|
| Visa® bank credit card | $622 |
| Utilities | $480 |
| Rent | $950 |
| Total | $2,052 |
| Long-term Liabilities | Market Value |
| Car loan | $8,245 |
| Student loan | $7,129 |
| Total | $15,374 |
| Total Liabilities ($2,052+ $15,374) | $17,426 |
Once you have values for all assets and liabilities, you can calculate your net worth using the formula:
Assets – Liabilities = Net Worth
Using this formula, changes in your assets or liabilities will also result in changes to your net worth.
Although establishing financial goals is one of the first steps in your financial journey, knowing your net worth today is an important financial data point that marks the real beginning of your lifetime financial journey.
Do you have any financial problems you're trying to solve like Tommy? Maybe it's setting aside money to pay your taxes. Perhaps you're budgeting for a new car. Before you can use your problem solving skills to make a plan, be sure you understand your current financial picture.
So how is Tommy doing regarding his net worth? The table below shows his net worth based on his assets and liabilities. As you can see, Tommy has a negative net worth of $3,199 (see Hint). Negative net worth is not uncommon, especially for recent college graduates just starting their careers. It is important to remember that Tommy’s largest and most important asset, his human capital, is not listed on the balance sheet. If his human capital was listed as an asset, his assets would far exceed his liabilities (this is why a bank was willing to give Tommy a car loan).
| Net Worth | Amount |
|---|---|
| Assets | $14,227 |
| Less: Liabilities | $17,426 |
| Net Worth | $(3,199) |
As you may have already guessed, your net worth estimate gives you a basic picture of how much money you would have if you sold all of your assets and paid off all your debts. This is the same as calculating what you are worth financially. The higher your net worth estimate, the better.
Let’s say that you have your net worth figure in hand. You are also committed to avoiding bad debt and paying off your liabilities as quickly as you can. If this is the case, then you are starting your financial journey wisely and in the most productive way. What you need now are guideposts that you can use to determine if you are on track to meeting your financial goals. Fortunately, you can use a financial ratio, which is a formula that tells you how well you are progressing financially, as a guideline.
Nearly every financial planner would argue that you should strive to be financially secure enough that you could pay off all your current (short-term) debts with your monetary assets.
The current ratio is the proportion of current assets to current liabilities. This ratio tells you if you are managing your short-term financial situation prudently.
The debt ratio is a broader measure of your financial health. This ratio shows your proportion of total liabilities (debts) to total assets. You should strive to limit debt to no more than 40% of the value of your assets (see Hint). For example, if you have $100 in assets, you should have $40 or less in total liabilities.
This table summarizes these two important ratios based on information from a balance sheet.
| Financial Ratio | Formula | Standard Benchmark |
|---|---|---|
| Current Ratio | Monetary Assets/Current Liabilities | Ratio > 1.0 or 100% |
| Debt Ratio | Total Liabilities/Total Assets | Ratio < 0.40 or 40% |
| Asset | Value | Liability | Amount |
|---|---|---|---|
| Checking account | $2,400 | Credit cards | $4,000 |
| Savings account | $9,000 | Mortgage | $224,000 |
| Brokerage account | $34,000 | Car loans | $30,000 |
| Home | $285,000 | Student loans | $18,000 |
| Cars | $32,000 | ||
| Household Items | $20,000 | ||
| Retirement plans | $123,000 | ||
| Other Assets | $89,000 |
Source: This content has been adapted from Chapter 2.4 of Introduction to Personal Finance: Beginning Your Financial Journey. Copyright © 2019 John Wiley & Sons, Inc. All rights reserved. Used by arrangement with John Wiley & Sons, Inc.
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