Paul Meloan – Vested Interest

A balance sheet is a simple document. It spells out all of the things you have (assets) and all of the money you owe (liabilities). The difference between these two numbers is your net worth. Creating a balance sheet and tracking its changes periodically can show you if your finances are on the right track.

A Balance Sheet as a Snapshot

The balance sheet is always stated as-of a specific date. It’s merely a snapshot of a moment in time and changes constantly. In most cases, it makes sense to update your balance sheet at least once a year. I have clients who review and update their personal balance sheet every three months. I will confess to doing this myself, although doing so more often than annually does not give much more insight. However often you update it, it’s important to have a regular process to understand the data and any changes.

So what goes into a personal balance sheet? Grab a pencil and paper, or a keyboard and a spreadsheet. Your document should list all your assets and your liabilities.

Assets: What You Own

It’s important not only to list out your assets, but to understand what kind of assets you own.

Liquid Assets

Liquid assets can be converted into cash within a few days with little cost. This category includes checking accounts, savings, CDs, stocks, bonds, and mutual funds. In fact, just about anything else held in a bank or brokerage account is a liquid asset. You may have to pay income or capital gains tax if liquidated.

Retirement Assets

Retirement assets are assets much like liquid assets, but with one major difference. They are typically tax-deferred or tax-free (Roth IRA) but only if held until you are at least 59 1/2. Withdrawing them before then would lose most of the tax advantage of holding them, and you may incur penalties.

Illiquid Assets

Illiquid assets have financial value, but can not be turned into cash quickly or easily.  The most common example of this is a closely held business. A person who owned a dry cleaners that made money has a valuable asset, but selling that business and converting it to cash would take time and energy. Rental real estate is another good example of slow-to-convert-to-cash assets. Illiquid assets are often valued based on some multiple of the amount of free cash flow they generate.

Use Assets

These are the things you own that have value, but much of their value comes from your use of them rather than their production of income or cash flow. If you own your personal residence then its value to you is not just how much you could sell it for. The fact that you have a place to live without paying someone else rent is valued as a use asset. Do not include your mortgage here; we’ll deal with that in liabilities in a moment. The same concept applies to your car. In many cases, use assets depreciate over time.

Personal Property

This is your stuff. If you have something that you would either throw away or donate to a yard sale tomorrow then its value (for balance sheet purposes) is zero. However, if you reasonably believe you could sell it for something, then its value goes here. Consider items such as jewelry, art or other big-ticket items here. These assets typically depreciate, sometimes rapidly. In these cases I try to be overly conservative with valuation and factor in how much it would cost to sell an item.

Liabilities: What You Owe

Mortgage Liabilities

The money you owe should correspond roughly to the things you have. Most common is a mortgage or home equity credit line for which your residence is the collateral. The same could apply to a loan against a car or other vehicle. Remember to adjust this number downward each year to reflect how much of the debt has been amortized (paid back) since the last time you updated the document.

Other Liabilities

List here any other debts you have in the world. As a rule of thumb, I include any debt that will not be paid in full within 30 days. I use that rule because many of my clients charge almost all their daily expenses to one or more credit cards. While technically this credit card amount is a liability, since it’s paid in full every month it has no impact on net worth. If you’re not paying your credit cards off in full every month, the balance you’re carrying goes here.

Once you have listed all your assets and your liabilities, you can compare the two and calculate your net worth.

Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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