There are two fundamentals that you should consider when evaluating your personal finances. One is your net worth and the other is your net cash flow. Once you understand the basics of each of these fundamentals, along with their importance, you will be in a position to measure your own financial health and then begin a program of setting goals and meeting them.
First, what isthe definition of net worth? Simply speaking net worth is your total assets minus your total liabilities. Essentially this reflects what you own minus what you owe and establishes your personal financial bottom line. Next, what is your net cash flow? This reflects what you have left over at the end of an income and expense period. If after paying your expenses at the end of this period, you have cash remaining then you have positive cash flow or a cash surplus. If at the end of this period you are in the hole and your expenses exceed your income, you are either operating at a deficit (or going into debt) thus your cash flow is obviously negative. The two fundamentals of net worth and net cash flow work together and seemingly go hand in hand in that assets are essentially the result of income not offset by expenses and a liability results in expenses which are not covered by income.
Below is an overview of the four financial components of net worth and net cash flow:
·
Assets – an asset is an
item of economic value which you own. It could include cash, real estate,
personal property (i.e. autos, jewelry, collectibles). It also includes
securities such as stocks, bonds, mutual funds or ownership in a business.
·
Liabilities – a liability
is a debt or something you owe. It may or may not be tied to an asset. For
example the liability of a mortgage is tied to your home (or real estate) which
is an asset, also the liability of an auto loan is tied to personal property
which is an asset, your car. Some liabilities are tied simply to expenses such
as any unpaid bills you owe for services extended to you.
·
Income – income naturally
reflects your earnings. Your total earnings could be from your job also from
any income producing assets that you have. Income is typically received in
periodic or cyclical intervals.
·
Expenses – expenses arise
from anything you purchase or acquire or any services you request.
It is a good idea to calculate your net worth annually.
Tax season might be a good time to put this on your calendar as it’s a
good time to take stock of where things stand financially. Your net worth is
subject to change and is a good barometer of year-to-year changes and will
assist you in determining whether you are heading in the right direction.
Calculating your net worth will also reveal the following:
1.How well your investments are performing overall? Are
you saving and adding to your investment accounts as planned? Are your
investments rising and generally keeping pace with the market as well as
competing investment opportunities.
2.Are you equipped to weather a financial emergency? Do
you have sufficient liquid assets to see you through a job loss or other
equally financially draining events?
3.Are you using credit wisely? Is your debt under
control and are you able to service the debts you have while meeting your other
short and long term financial objectives? Or is your debt out of control and
your debt servicing increasing faster than your earnings preventing you from
meeting your other financial goals.
4.How are you managing life’s risks? Are you
properly insured to protect yourself, your family and your assets? Do you have
adequate medical, disability, homeowner’s (or renter’s) and life
insurance to protect any dependents?
Please read our continuing series that looks at money management in all forms:
