Here’s a great article about what a statement of net worth is, by Steve Raiser, a Los Angeles personal injury attorney.
A Statement of Net Worth (SNW) reflects an individual’s financial health at a moment in time. The formula used to reflect a positive or negative “health” is simple: Assets – Liabilities = Net Worth. When assets exceed liabilities you have a positive net worth. Vice versa, when there are more liabilities than assets, you have a negative net worth. In general, a positive net worth is seen as the goal. Financial advisors, accountants, and individuals see a SNW as a scorecard that should change and improve over an individual’s or company’s life. As an individual, preparing an annual statement like this serves as a scorecard, of sorts, that lets you know if you’re making progress towards financial goals.
Uses of a Statement of Net Worth
There are concrete uses for a SNW besides using one to determine how your progress is going. Here are a few of them.
* Planning – If you look at life as a football game, a SNW allows one to see where adjustments need to be made along the way. If your favorite college team reaches the end of the third quarter on the short end of a 28-10 score, the coach knows that if he plans to win the game his team needs to put more points on the board. Simplistic? Maybe. That doesn’t make it any less valuable. He needs more assets and so do you. This statement can show if you have too few liquid assets or that your investments are overloaded in one industry or area.
* Satisfy Lenders – A lender will likely ask you to fill out a SNW at some point along the way in the lending process. Whether it’s for a car, house, or college loan, this statement is part of the process used to decide whether or not loaning money to you is a good idea. A negative statement and too little income is a red flag.
* High-Risk Investing – An investment broker or financial advisor might want to see a SNW before allowing you to put money into certain high-risk opportunities. It’s bad policy to over-leverage yourself to the extent than a single, violent downtown by a finicky market could throw you into financial chaos or even bankruptcy.
* Divorces: Highly valuable in the divorce process, your lawyer will have you fill out a SNW in the early stages of the proceedings. Child support and alimony rely largely on the results of this statement.
As you may have gleaned from the discussion thus far, one of the major categories involved in calculating net worth is assets. While not a complex task, there are several subcategories involved in this tally, some of which you might overlook without a checklist.
* Liquid Assets: This includes cash or anything that can be easily converted to cash like CDs, money market funds, short-term treasury notes, debts owed you under written contract, and life insurance policies.
* Personal Use Assets: Belongings that might fall into this category include household goods, sporting or hunting equipment, collectibles, cars and motorcycles, etc. The connecting thread is that these possessions could be sold for cash without much trouble.
* Long-Term Assets: This category includes those assets (investments) that you expect to hold at least one year, often much longer. Think stocks, bonds, real estate, business equity, commodities, or retirement plans. These types of assets are not always quickly converted to cash but do hold a definite – sometimes significant – value in your portfolio.
Serving as the yin to the yang that constitutes assets, liabilities are broken down into the two main subcategories listed below.
* Current Liabilities: Defined as bills or debts that come due within 30 days. This category is meant to reflect ongoing monthly expenses like rent and utilities, credit cards, taxes, and the current portion of long-term debt (the monthly amount due on a long-term loan).
* Long-Term Liabilities: Any liability that you pay back over a long period of time (in this case more than 30 days) goes into this category. This normally includes any part of a loan that falls outside the “current” definition.
The work involved in collecting information on all your assets and liabilities isn’t always reflected on the SNW, which is often a one-page compilation of your research. Generally assets are categorized on the left, liabilities on the right, and the verdict (positive or negative net worth) on the bottom right. If you’ve never created a personal SNW, make it a habit going forward. If life is a game, which it often feels like, there’s no better way to keep score than adding up your finances.