Understanding Your Personal Balance Sheet

Title: Understanding Your Personal Balance Sheet Image Description: A visually appealing infographic featuring the top 10 financial tips for entrepreneurs. The infographic is designed with vibrant colors and clear, easy-to-read text. Each tip is accompanied by a relevant icon or illustration to enhance understanding. The tips cover various aspects of financial management, including budgeting, saving, investing, and tax planning. The infographic is designed to be visually engaging and informative, providing entrepreneurs with practical advice to improve their financial well-being. What is Your Personal Balance Sheet?

At some point, you have probably come across the term “balance sheet,” in the news or in an Accounting 101 class. But what actually is a balance sheet?  

Balance sheets are a snapshot of a company’s financial standing and an integral part of the audited financial statements that public companies are required to produce every year.  Together with an income statement, a statement of cash flow, and numerous pages of notes and details, they represent a company’s financial health or wellness as of a given date, usually the fiscal year-end (i.e., 12-month accounting period) reporting date. You can easily go online to find and download the most recent annual report, in all its complexity, for any large company, such as the one here for Coca-Cola.¹ 

However,  a balance sheet can also be a simple financial concept that can be used to help you think about your own financial wellness. Everyone has a personal balance sheet, whether or not you have ever created an actual file using this term. A balance sheet is merely a way of organizing information that can give you insight into your personal financial situation. Analyzing it on a regular basis might suggests some steps you can consider to improve your financial health.

Balance sheets divide your financial reality into two distinct categories: “assets'' and “liabilities.”  Assets are the things that you have or own: your bank accounts, investments, home or other property. Assets can also consist of intangibles, such as your education, work experience, energy, integrity, network, or community.

Liabilities are the things that you owe: your credit card balances, student loans, mortgage or any other debt. Intangible liabilities might include less useful character traits or areas of improvement, such as a lack of confidence, training, or knowledge.

The third, and in many ways the most important, element of a company or personal balance sheet is “equity.” A balance sheet must always balance. By definition, assets must equal liabilities plus equity, which means assets minus liabilities equals equity.

 Assets = Liabilities + Equity   ↔ Assets - Liabilities = Equity

There are other terms that are often used to describe equity or assets minus liabilities. “Net assets” and “net worth” are among the most common, but they all mean the same thing: what is the result when you add up everything you own and subtract everything you owe? Note that if your liabilities exceed your assets, then your equity or net worth will be negative — more on that below.

Why is all of this important? As individuals, if we only look at our bank accounts or only at our credit card statements, we would not get a complete picture of our financial position and could not properly assess our financial health.

It is worth noting that balance sheets only give you a snapshot of a company’s or a person’s financial position at a particular point-in-time. But where did your assets come from? You may have incurred some debt to acquire some of your assets like a car or a home, but the money in your bank and investment accounts had to come from a source. For most, the money likely came from your income. Ta-daah…there is a reason why financial statements include the income statement.

In any given year, you made X amount in salary, bonus, tips, commissions, fees for services rendered, etc., and possibly some additional income from investment returns. You also had expenses, such as rent or mortgage payments, food, clothing, utilities, travel, and entertainment. Your net income, the result of subtracting your expenses from your income,  would then go on your personal balance sheet. In the (hopeful) case that your net income is positive, your assets would increase, and your net worth would also go up.  

But even if your net income is negative in a given year, the number would still go on your balance sheet: 1) your equity/net worth goes down and either assets go down, because you funded the shortfall with cash in the bank or an investment that you sold; or 2) your liabilities go up because you funded it with new debt like a mortgage, a home equity loan, or a credit card balance.

So think about your personal balance sheet.  Do the math. What are your tangible assets?  What are your liabilities? What is your net worth? What are your intangible assets and liabilities and how are you managing those for your benefit in the future?

If you just finished law, medical, or business school and have yet to inherit a fortune from your rich relative, chances are your net worth is negative. You might have a decent chunk of debt from student loans and living expenses and have yet to make a consistent salary that would allow you to accumulate cash and investments.

Take a deep breath. The good news is that you’re not alone and this is a highly solvable problem!  You have the intangible asset of your education which has landed you a great job (or soon will!) with a steady income that will allow you to either accumulate assets or reduce your debt over time - improving your financial wellness as you grow your net worth.

If your net worth is negative and gets worse each year, you need to take a serious look at your expenses and lifestyle and find a way to increase your assets — tangible and intangible — that can improve your income now and in the future. Sadly, in financial wellness, it’s nearly impossible to eat your cake and have it too. You might need to spend less and/or find ways to earn more. 

Regardless of how your personal balance sheet looks now, there are always steps you can take to improve or optimize your financial wellness.  At Litmus Financial, we would be happy to help you think about your personal balance sheet and financial health in the context of your unique life circumstances, including your longer-term goals and objectives in life.* Insert call to action/link here*

Notes:

1.  See pages 63-66 for the Income Statement, Balance Sheet and Cash Flow Statement, page 67 for the Equity Statement, and pages 68-125 for the Notes.

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