Analyzing a balance sheet you built for yourself can help you get a better understanding of your personal net worth. A balance sheet is a summary that shows your assets—possessions like cars and your home—as well as your liabilities or debts. A business will commonly use a balance sheet to help keep track of its finances, but the method also helps individuals.
Own vs. Owe Equals Net Worth
You may want to know your net worth out of curiosity, to see where you rank among your peers, or because of a particular reason, such as applying for a loan. As an example, let's say you are going to apply for a loan to put a swimming pool into your backyard. You go to the bank asking to borrow money, and the banker insists that you give him a list of your current finances.
After going home and looking over your statements and account records, you pull out a blank sheet of paper. You write down everything you have that is of value including your checking accounts, savings accounts, certificates of deposit and money markets, mutual funds, stocks, bonds, real estate, cars, furniture, computers, and more. Then, you write down everything you owe including your mortgage, student loans, credit card debt, margin debt, and more. Finally, at the bottom of the sheet, you subtract everything you owe from everything you own to calculate your net worth.
Congratulations, you have created a balance sheet.
The Necessity of Business Balance Sheet
Just as the bank asked you to put together a balance sheet to evaluate your credit-worthiness, the government requires publicly traded companies to put together a balance sheet several times a year for their shareholders. These balance sheets allow current and potential investors to get a snapshot of a company's finances and decide if they are good investments.
Among other things, the balance sheet will show you the value of the things the company owns—right down to the telephones sitting on the desk of their employees—and the amount of corporate debt they have floated. The balance sheet is usually one of the first financial statements you want to analyze when you are valuing a company for investment.
Different Types of Balance Sheets
A corporation, limited liability company, or limited partnership balance sheet differs substantially from an ordinary household balance sheet because there are a lot of complex items in the accounting records of an operating enterprise or holding company.
Businesses have to deal with all sorts of difficult questions that most people do not deal with on a personal level. These business issues include how to depreciate and cost out a jumbo jet to accounting for the construction expenses of a power plant.
The Elements of a Personal Net Worth
Before you are capable of analyzing a balance sheet, you have to know how it is structured. The best way to do this is to remember that the entire purpose of the balance sheet is to answer three questions:
- What do I own? (Assets)
- What do I owe? (Liabilities)
- What is left over? (Book value or shareholder equity in a business)
As you determine your net worth, you will—naturally— also create a cash flow statement. This statement shows a line by line accounting of your inflow and outflow of money over a specific period.
Cash flow includes your assets or money you earn as a salary, get from interest on savings or other accounts, earn from dividends on investments, or gain from the sale of an investment—known as a capital gain. Each item should represent a separate line in the cash flow statement.
The cash flow also shows all of your outgoing funds. You include things like rent or mortgage payments, insurance and property taxes, groceries, gas for your car, utility bills, and entertainment. Anything that you pay for with one of your assets.
If you have money left after deducting your expenditures, you have a positive cash flow.
Balance sheets help to summarize your net worth for a specific period. Again, you are working with assets and liabilities. Here, however, you will split your assets into three primary categories, liquid, large, and investments.
Liquid assets are checking and savings accounts and cash. Things that you can immediately turn into cash if required. Homes, cars, boats, furniture, clothing, and other such possessions fall into the category of large assets. Any investments in stocks, bonds, certificates of deposit CDs, or other such items are investments. Group each of these assets by category, total the values and enter it for that line of the balance sheet.
Your liabilities here are the same as in the cash flow statement and include loans, credit card balances, and other payments you make within the timeframe of your analysis. You can further separate liabilities into discretionary and non-discretionary spending. Non-discretionary spending for an individual are things that you must have to live in modern society such as food, medicine, and housing but also includes the cost of utilities, insurance, and taxes.
Probably the greatest benefit from creating a balance sheet and a cash flow statement is that you are better able to see exactly where you are spending. The numbers won't lie. For example, you might see that you are spending more than you thought you were on renting movies or eating out each month. By reducing these discretionary expenses you may be able to pay more on a credit card debt or loan and pay it off quicker.
The figures on the balance sheet are specific to the timeframe under review. Unlike other financial statements, the balance sheet cannot cover a range of dates. In other words, it may be good as of December 31st, but it can't tell you about a period spanning from, say, December 1st through December 31st. It is because a balance sheet lists items such as cash on hand—and inventory for businesses—which change daily.