Your personal balance sheet
Posted Saturday, June 30 2012 at 01:00
- A good balance of fixed and liquid assets ensures that you can survive emergencies as well as have a stable financial future.
Before you get where you are going, you have to understand where you are coming from.
Over and above a budget, we need to know how much we are worth by compiling a Personal Balance Sheet, which provides you with an estimate of your financial value.
As you plan your money and investments it also enables you to see what areas you should be focusing on. It is a summary of your assets (what you own), liabilities (what you owe) and net worth (assets minus liabilities).
Assets can be separated into two categories. Liquid assets are those things that can easily be sold or turned into cash.
This includes money you may have in a savings account or Sacco account, short-term treasury bills, shares, unit trusts etc. When trying to figure out what your liquid assets are, ask yourself what you would have ready access to in case of an emergency.
Fixed assets are longer term investments such as land, property, investment in business, pension or provident funds etc. These assets cannot be liquidated easily but they do provide the long-term growth needed for things such as retirement planning.
Note that personal items such as a cars, furniture, electronics etc do not form part of this analysis. Not only are they constantly depreciating in value but you cannot rely on selling them and realising any gain, should you need to.
A balance between fixed and liquid assets is needed. A lot of people have found themselves ‘asset rich’ but ‘cash poor’ by not keeping a good balance of liquid assets that they can survive on after retirement or in an emergency.
You should plan to build up about six to 12 months of your monthly expenses in liquid form. At the other extreme, you don’t want to have all your investments in cash with nothing creating value for you in the long- term.
Liabilities are what you owe. This includes loans you may have taken for investment purposes such as to buy property, invest in a business etc. It also includes personal debts such as credit card balances, outstanding debt on a home mortgage, car loans, furniture loans etc.
Your net worth is the difference between your assets and liabilities. This figure is your measure of financial value because it represents what you own after everything you owe has been paid off. Your net worth also shows how long you can survive without another source of income.
Divide your net worth by your monthly expenditure and you will be able to see how far or how near you are to financial freedom.
If you have a negative net worth, this means that you owe more than you own and decreasing your debts should be a priority. You can also increase your net worth by increasing your assets.
Remember that if you take on debt to make an investment, the value of the asset should be more than the debt. Decreasing your spending or increasing your income allows you to invest more and hence increase your net worth.
If your net worth is positive, continue building on that and increasing your assets in line with the specific objectives you have set.
Waceke Nduati Omanga| firstname.lastname@example.org | Twitter@centonomy.