Keeping track of your finances can help you make sound decisions in financial matters. A fair assessment of your position is critical to achieve savings or repayment goals because it will tell you how much extra funds you can afford to put into these areas.
However, it’s not easy to fully understand your financial situation, and lack of specific evaluation measures make it very difficult to determine if your finances are strong or if you need help.
Account balances may give an idea of how much cash there is at any given point of time but they only reflect one side of the financial position of an individual. It is the net worth, which actually reveals your true financial health. Net worth, simply put, is total assets like cash, house, bonds etc minus total borrowings like mortgages, credit card debts, and other payables.
It is important to note here that the value of assets fluctuates and this needs to be taken into account to give you a realistic estimate of your position. If for example you owned a yacht then the value of this would be tangible at best.
For instance, if a lot of your investment is locked up in real estate, then you can’t simply use the purchase price to calculate your net worth. The value of the house may have plummeted or soared, and only the current market value will give a more accurate estimate of what your investment is worth today.
Net worth must be evaluated periodically
Say each month, or at least once every quarter. Of course any changes or pay offs or new borrowings must be recorded as well with a note detailing the entry for future reference.
Your assets at a given point of time will be in many forms – cash, bonds, retirement funds and savings accounts. These can be categorized according to their liquidity for ease of accounting. Any borrowings that will not carry over beyond a month need not be mentioned in the monthly net worth assessment. Making a list of all the assets and borrowings under specific headings can help in understanding how the assets fare against liabilities. Setting the liabilities off against the assets will give an accurate picture of your financial health.
The point of the whole exercise is to gain a better understanding of where your money is going and how you can manage your finances better. This will also allow you to take good financial decisions, which can significantly reduce your debts and add to your assets.