It is a requirement for public companies (and a good idea for private companies) to compile and produce reports based on their financial positions. It is likely you have heard of at least one of these types of reporting: balance sheets, income statements or cash flow statements. Each provides a different picture of a firm's financial well-being. In a similar manner, people can create for themselves comparable outlines of their own fiscal positions. This is done by calculating one's "net worth," which is a simple equation consisting of adding up one's assets and subtracting off his or her liabilities. This immediately begs the question of how one might go about improving the outcome of the equation and improving one's net worth. First, some brief terminology review. An asset is essentially anything you own which has some cash value: your bank account, your car and the spare change in your wallet all count toward your tabulation of "assets." It is essential to think of your assets in real cash terms or "market value." Do not estimate value based on what you paid or on intangible elements like sentiment. Only consider the "liquidation value."

Calculating Net Worth
In other words, if you were to sell this particular asset today, what would be the price received? This can be tricky as many people overestimate the value of certain objects or ascribe value where none is warranted. An item is only as valuable as the amount of money someone is willing to pay for it. It is also appropriate to include your salary and any income derived from investments. Liabilities, for our purposes, are basically what you owe. The balance of your mortgage, credit card debt, student loans, or even things like rent and utility bills are all examples of liabilities. While assets can be thought of as cash "inflows," liabilities can be considered cash "outflows."

Increasing Net Worth
These are a bit easier to evaluate as often a third party is dictating the nature of your liabilities. If net worth is the calculation of our assets minus our liabilities, then it should be obvious that to increase net worth, one must increase asset holdings or decrease outstanding liabilities. The problem is that for many increases in assets there is a commensurate increase in liabilities (eg. buying a house usually requires a mortgage). Additionally, people only make so much money at their jobs, and negotiating a raise may be difficult. This creates a necessary limit on asset creation as spending beyond your ability to pay will accrue debt. This does not mean that someone should never buy a house or only buy a house with cash reserves, instead it is meant to illustrate the interconnected nature of assets and liabilities. Ideally, one should pursue a strategy that allows for the beneficial movement of both assets and liabilities simultaneously. A good example of this would be investing in a 401(k).

Making Small Changes
This defers your tax-liability and increases your asset holdings. The difficulty faced by most people is that they do not have the residual income necessary to adequately increase their assets beyond their liabilities. Therefore, the most appropriate measure to undertake in order to increase net worth is to examine your spending habits or your cash outflows. Finding a new, better paying job, is not as easy as deciding to forgo dining out one day a week. Note how you are spending money (your liabilities) and identify ways of reducing that burden. By reducing the amount needed to service debt, you increase the amount of money available to go into asset creation. Remember, decreasing liabilities is not simply about decreasing your debt payments; it is about managing your overall spending. Decide not to buy the latest smartphone or turn off lights when you are not in a room. Small changes in behaviour can go a long way toward reducing your expenses. The bonus is that by trimming back on what you can and growing your assets, you can create more value that can be borrowed against in the future thus allowing you to increase your assets at the expense of your liabilities.

The Bottom Line
Taking the time to look into your household's net worth can tell you many things and it really is a balancing act. Incurring a liability is not necessarily a bad thing if it means getting a new car when the old one breaks down or an education to improve job prospects. The important thing is that we adequately and appropriately budget for these items and ensure that they add value over the long term. A new car to replace a dangerous clunker is a "good" purchase whereas buying a new convertible due to a mid-life crisis is less so. Assets and liabilities play off of one another, improving your position in one allows you to make gains in the other. How you do this really comes down to your own personal spending habits and how quickly you want to be able to enact change to improve your financial health.

Related Articles
  1. Personal Finance

    Assets That Increase Your Net Worth

    Your home, properties and vehicles can all increase your net worth.
  2. Investing

    The Importance Of Knowing Your Net Worth

    It is vital that you track your net worth no matter what your age.
  3. Personal Finance

    The Complete Guide To Calculating Your Net Worth

    Here's everything you need to know about calculating your net worth.
  4. Investing

    3 Small Steps to Maximize Your Investing Goals

    Instead of starting the New Year with ambitious resolutions, why not taking smaller manageable steps that can have a real impact.
  5. Credit & Loans

    Top 5 Reasons Why People Go Bankrupt

    The biggest cause of bankruptcy in the United States is medical expenses.
  6. Philanthropy

    How Billionaires Around the Globe Give Back

    This list of foreign billionaire philanthropists is robust. Here's a list of rich entrepreneurs around the globe who have given back in really big ways.
  7. Home & Auto

    What to Do When You Can No Longer Afford Your Car

    Life is full of unexpected and undesired events, like layoffs or divorce. Unfortunately, these events can sometimes make your car payment unaffordable.
  8. Savings

    How to Save Your First $100,000

    Saving your first $100,000 requires the discipline to put money away and control your spending. But just remember – the savings get bigger as you go.
  9. Insurance

    Cashing In Your Life Insurance

    In tough economic times, tapping into a life insurance policy can provide a needed source of funds.
  10. Credit & Loans

    Debt Forgiveness: How to Get Out of Paying Your Student Loans

    There are income-based plans and forgiveness for public-service employees. The latest wrinkle: loan forgiveness because the school defrauded you.
RELATED FAQS
  1. Can a debt collector contact me about a debt that's no longer on my credit report?

    According to Experian, a debt collector is permitted to contact a consumer about a debt that is no longer on the consumer's ... Read Full Answer >>
  2. Are personal loans considered income?

    Personal loans are not considered income for the borrower unless the loan is forgiven. In other words, you cannot be taxed ... Read Full Answer >>
  3. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  4. Can personal loans be included in bankruptcy?

    Personal loans from friends, family and employers fall under common categories of debt that can be discharged in the case ... Read Full Answer >>
  5. Can Sallie Mae loans be consolidated?

    Sallie Mae loans can be consolidated with other federal loans, but not with private loans. For federal loan consolidation, ... Read Full Answer >>
  6. How does Sallie Mae disburse funds?

    Sallie Mae is the number one provider of financial aid and student loans in the United States, servicing over 25 million ... Read Full Answer >>
Trading Center