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Finance Doesn’t Have to be a Bad Word
Although it is important to get to grips with financial concepts, you by no means have to take a Masters Degree in Finance in order to understand the key concepts that are required to successfully plan for your financial freedom. In this article we are going to start by teaching you how to create a simple but very important financial statement. Naturally a tool is useless if you don’t know how to use it though, so after you’ve learnt how to make the statement, we will explain how, and why you should use it.
Now that you’re ready to learn, the first step to achieving financial freedom is understanding what your current financial situation is, and one of the easiest ways of doing that is by creating a net worth statement for yourself. A net worth statement is a very simple tool that tells you what the value of your household is in purely numerical terms. The formula is as follows: Total Assets – Total Liabilities = Net Worth. Learning how to calculate your net worth is an important part of financial literacy, and therefore a critical step on your path towards financial freedom.
Step 1: Calculate Your Assets
Assets are anything that you own that has a worth. The value you assign to each asset, should be the market value, i.e. how much you would get for the item if you sold it today. Here is a list of items that you should put in your asset column:
Step 2: Calculate Your Liabilities
Liabilities are essentially debts, as with your assets take the value of your debts from the day you are completing the exercise. Here is a list of items that you should put in your liabilities:
Step 3: Calculate Your Net Worth
The next step is to add up all your different assets, and then separately add up your liabilities. Once you’ve done that, you can follow the formula above, and simply subtract the total sum of your liabilities from the total sum of your assets. The result you get is your net worth.
Let’s create a little scenario to make this a bit easier to follow. Everyone, please meet Bernadette, she wants to know what her net worth is, and created the following list of her assets, and liabilities.
When looking at Bernadette’s net worth, the first thing to note is that her net worth is positive. That is a very good start since the aim is obviously to have as high a net worth as possible. We can also see that the majority of her liability is in her mortgage, which is generally considered to be a good debt since property prices historically tend to rise. Although car loans are very typical, and with vehicle prices continuing to rise, also increasingly necesssary; it is not a good debt because a vehicle is ultimately a depreciating asset, which means that as time goes by it falls in value. Credit card debt would also be considered a bad debt, mainly because it is one of the most expensive types of debt with typical interest rates around 20%.
Financial Literacy is Key to Financial Freedom
The short analysis above is really the main benefit of completing a net worth statement. By doing a net worth analysis for yourself you will gain an easy and quick oversight of your financial situation. Because it is such an easy statement to complete, it’s also a great way to track your path to financial freedom. If you are actively working towards your financial freedom then we would recommend spending some time every three months to complete it. Hopefully you will be making progress, and seeing your net worth increase can be a great motivational booster to keep up your efforts.
