In this article, I’d like to help you understand your current financial status. The tools you’ll learn about include a balance sheet and summary of debts.
Creating a Balance Sheet
A balance sheet is like a snapshot of your financial position at one point in time. It is simply a listing of your assets (what you own) and your liabilities (what you owe). Assets minus liabilities equals your net worth.
For most people, their balance sheet changes pretty dramatically during their lifetime. College students typically have almost no assets and often have student loans, so it’s not unusual for them to have a negative net worth. A young married couple starting a family begins to add assets such as automobiles and their first home, but these normally come with a lot of debt attached. So the young couple’s net worth doesn’t change all that much in the early years.
As people get into their forties and fifties, it’s important that their net worth grows sufficiently to meet upcoming needs, such as paying for college and retirement. While circumstances vary, it’s not unusual for people in their retirement years to tap into their assets to meet day-to-day needs. This results in a declining net worth. Their goal would be to certainly have adequate resources to meet their retirement needs and to pass on a reasonable inheritance for their children.
So you can see, there really isn’t one balance sheet that is standard for everyone. It depends on your stage in life and the responsibilities the Lord has entrusted to you. Let’s make sure we understand the parts that make up the balance sheet.
Assets, Liabilities and Net Worth
Once again, an asset is simply something that you own. Assets are listed on the balance sheet at their fair market value, in other words, what they could be sold for today. We categorize assets on the balance sheet as follows:
• Cash and Cash Equivalents: These are assets that are readily converted into cash and include such things as checking accounts, savings accounts and money market funds. Money market funds would normally be owned within the account you have with a stock brokerage account. You can access it easily and without incurring a penalty for making an early withdrawal. These historically offer a higher rate than a money market account with a traditional bank. However, times are changing, and some banks are offering competitive rates. Make sure you compare rates before deciding where to hold your cash equivalents. A good part of your rainy day fund should be placed in your money market fund.
• Insurance: The cash surrender value of permanent life insurance policies is a bit of an oddity. While in most circumstances, I recommend term insurance, some people already have policies with a cash value. You may decide to switch to term (make sure to have a new term policy in place before canceling your permanent policy), in which case the cash value can be used for other purposes, including paying down debt. If you plan on keeping your existing cash-value policies, I would include the cash value under Invested Assets.
• Invested Assets: This category includes such things as certificates of deposit, stock, mutual funds, retirement plans, precious metals, investment real estate, vested pension benefits, ownership interest in closely held businesses and other similar assets. The hallmark of these assets is that you are putting them to work so that they grow in value over time to help you meet your life’s goals. They are not as easily converted to cash in the short term.
• Use Assets: this category includes your personal residence, automobiles, boats, and personal effects such as home furnishings and jewelry. Again, you should value them at the net price you could obtain for them today.
As noted above, when you have a liability, it means you owe a debt to someone. Sometimes the debt is secured by one of your assets (for example, your home or automobile). At other times, the debt is unsecured, meaning it is not tied to any of your assets (for example, credit card debt and personal debt to friends and family). Debts are listed on the balance sheet at the amount you owe today. Here are some common types of liabilities:
• Mortgage and Home Equity Loans
• Automobile Loans
• Credit Cards and Installment Loans
• Student Loans
• Business Loans
• Other (loans from family and friends; retirement plans; life insurance)
Net worth is the difference between assets and liabilities. It is an important measure that can reveal how well you are doing toward meeting your future financial needs.
How to Use a Summary of Debts
The summary of debts is a supporting schedule for the balance sheet. This form provides all of the critical information relating to your debts — who you owe money to, the current balance, number of payments remaining, interest rate, the minimum payment required, and a description of what it was that you purchased. This worksheet becomes very useful to help you start rapidly paying off your debts by creating your personal accelerator repayment plan (See www.VeritasFinancialMinistries.com). You’ll see how important it is for you to understand what the interest rate is that you are being charged on your debts. While you’ll save more money paying down your highest interest rate debts first, some people prefer the emotional boost they get from paying down smaller debts more quickly. You’ll want to choose the method that works for you.
If you haven’t completed a balance sheet or summary of debts before, now would be a great time to get started. Once you have your information summarized, review your balance sheet in light of the 7 steps to becoming financially free. Do you have $2,000 set aside for an emergency fund? Do you have any consumer debt, such as credit cards or auto loans? Do you have rainy-day savings set aside above and beyond your $2,000 emergency fund? Are you saving for future needs, such as a house, college for the kids, and retirement? What is your net worth?
What does the Summary of Debts reveal? Do you pay all of your credit cards in full every month, or do you have outstanding balances? If you have outstanding credit card balances, what are the interest rates you are being charged? Are you paying the minimum balance? If you are, be prepared to take many years to pay off your balance. The credit card companies use formulas that extend payment over many years and cost you a lot of interest. Visit www.veritasfinancialministries to see how to eliminate it using the Accelerator Repayment Plan.
Phil Lenahan is President of Veritas Financial Ministries. If you have questions you would like Phil to address, please email them to [email protected]. You can also up for the free Veritas Financial Ministries E-Letter at www.veritasfinancialministries.
