In the simplest form, a company generates profit for its owners by operating a business. A company employs an accountant to be in charge of bookkeeping and managing its finances. This is essential: Owners must receive accurate and timely financial information, to ensure the business is on track at all times. This information also reflects potential problems and reveals opportunities to do better.
Come to think of it, we as individuals really aren’t that different from a company. We work to generate income, aiming to build up enough wealth to achieve our financial goals. Shouldn’t we take the same rigorous approach towards our finances that any company would?
Many people either find this unnecessary, or just too complicated – but all you need is a good grasp on a few basic accounting concepts to start making sense of your financial situation.
Let’s start with the balance sheet – a snapshot of your financial state at a given point of time. Sit down with a blank piece of paper. On the left side, list down the assets you own, and their respective dollar value. Assets are resources under your total or partial ownership, which can be used to generate economic benefits now or in the future. On a personal balance sheet, they would commonly include cash, stocks, bonds, mutual funds, your MPF balance, gold, or property. Notice that all of these are convertible to cash, though with different levels of liquidity (meaning some are faster or easier to turn into cash than others).
Make sure you write down the current market value for these assets, not how much you’ve paid to acquire them. In the case of property, for example, your holdings aren’t worth what you originally paid for them, but what you can sell them for at this very moment.
On the right side of the balance sheet are your liabilities: your IOUs, or your obligation to pay something to others in the future. This would include your mortgage, car loan, personal loans (inclusive of outstanding credit card balances). List out these items, and put the value of the outstanding payment as of today. For example, your mortgage loan amount was $4,000,000, and you have already paid off $1,200,000, put “$2,800,000” as Outstanding Mortgage.
Net Worth or Equity
Now add up the value of all your assets, and compare that to your total liabilities. The former will (hopefully) be larger than the latter. The difference is your net worth – what a company would list as “equity” on its balance sheet. This a very important number is basically the value of You, Inc. – and the number you’ll need to work hard to maximize. And even if your net worth is negative, that’s not necessarily disastrous. It might just mean you’re en route to building up your wealth, and in time, the number will turn positive.
How Is This Useful to You?
1. It’s a clear, quantifiable way to track your progress.
By updating and reviewing your balance sheet regularly – say, annually – you can keep track of your financial progress. Is your net worth growing healthily? Are you on track with your goal?
2. It steers you towards working smart.
To maximize your net worth, you can either increase your assets, or decrease your liabilities. The balance sheet numbers tell you which aspect is most important to address, and where you can find opportunities to grow your net worth faster. If your car loan is creating a stubborn dent in your net worth, consider selling that car and paying off the loan. If your property has appreciated substantially, should you seize the opportunity to refinance and lower your interest rate?
3. It sharpens your financial sense.
As a former shopaholic, I wish I had embraced this balance sheet idea much earlier! The fashion and style media keeps telling us how an expensive cashmere coat is an “investment asset,” because you can wear it a hundred times and each time only costs $300! Well, the coat doesn’t even make it to the asset column. Why? The flea market resale value is probably just $500. This coat is not an asset. It was an expense.
The same goes for a brand-new convertible roadster. Consider its resale value, and enter its asset value honestly in the balance sheet. You might still decide to buy that coat and convertible roadster, but at least you’ll know what you’re getting into financially!
It’s a new year – time for resolutions! Why not make this financial review a yearly exercise, too?
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