The Power of Net Worth: Using the Basics to Get a Grasp on Your Life
If you have ever heard of or learned about the basics of accounting, often heralded as “the language of business,” you will almost certainly have come across this formula:
Assets = Liabilities + Equity
This formula is one of the foundational building blocks that is used around the world to make sense of the accounting industry and financial markets every single day. Each year new business students will learn about this formula, apply it in numerous ways throughout their studies, and undoubtedly refer to it as a blueprint for their career as they move out of their college lives.
So, what exactly does this formula mean? Similarly, how does this translate to understanding the power of our net worth?
Well, let us first begin with understanding this formula from a broad perspective.
The first component of this formula, the assets, is generally regarded as something that a person or entity owns that can be used for or liquidated into something that produces a positive economic value for their owner of the asset.
Next, what is a liability? A liability is generally heralded as the antithesis to an asset. As defined by the Corporate Finance Institute, a liability is a financial obligation of a company or person that results in the future sacrifice of economic benefits to other entities or businesses. To put it plainly, a liability is something that brings about negative economic value for a person or entity.
Finally, let’s tackle the equity portion of the formula. Equity in this regard usually is only applicable to companies and large businesses, but that is not always the case. According to the Corporate Finance Institute, equity is the value that is attributed to the owner(s) of a business, which is often calculated by finding the difference between one’s assets and liabilities.
Again, this formula is used almost universally by businesses around the world in numerous ways. So, how can this formula be used in our own lives to help us understand our personal net worth? Let’s simply look at the assets & liabilities portion of this formula and apply it to our lives.
Let us consider a hypothetical situation where someone has $10,000 cash, $250,000 in home value, and $12,000 in fine jewelry. This person also owes $25,000 in student loans and $15,000 on a car they are financing. If our goal is to simply determine a broad understanding of what this person’s net worth is, all we have to do is simply add up their assets, do the same for their liabilities, and then take the difference.
In this case, this person would own $272,000 in assets and $40,000 in liabilities. By taking the difference of these two numbers we find that the person in our hypothetical example would have an estimated net worth of $232,000. To be clear, this number is not an exact number since there are still other factors that could change the final total. However, it should simply be viewed as a starting point and a general estimate of one’s net worth.
By breaking down the tried and true accounting formula we find that someone could very easily gain a grasp on their personal net worth. By understanding your net worth this allows you to gain a grasp on where you are financially, and gives you better clarity to discovering where you want to go in the future. Feel free to play around with this formula and discover what your net worth is. The results might just surprise you, and may even spark the fire you need to make progress in your life.
By: Daniel Trentham, Marketing Coordinator at CROFT & FROST
Sources:
https://www.investopedia.com/ask/answers/12/what-is-an-asset.asp
https://corporatefinanceinstitute.com/resources/knowledge/finance/liability/
https://corporatefinanceinstitute.com/resources/knowledge/finance/equity/