Understanding Net Worth

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source: http://themontanagroup.ca

I know you don’t want too technical terms but I guess in order to excel in investing one has to familiarize oneself to the terms use in business. A good way to start as everyone says is to instead of reading the entertainment section of the daily newspaper go first to the business section. There you will find business lingo that probably you have never heard in your whole lifetime. Don’t be ashamed to ask somebody if you don’t know what it means, don’t be ashamed to increase your financial I.Q.

With that let’s focus on Net Worth.

Dictionary.com defines it as:

“The amount by which a company or individual's assets exceeds their liabilities. “

In accounting it is explain by re-arranging the Balance Sheet equation:

Capital (Net Worth) = Asset – Liability

Where: Asset = things you or your business own

           Liability = things you or your business owe to
           someone else

With this Net Worth simply means your actual value.

This is important because as one compares a company to another one has to look where the company stands. A company which has a positive net worth simply means it is well funded thus it is able to fund its current operation without fear of default in paying suppliers (too technical right?)

A negative net worth commonly known as deficit on the other hand means that a company is out of enough assets to settle its obligations. There is a fear that operations may stop and creditors may run after the company’s asset to satisfy obligations. It also means that the company is more of type which is owned by its creditors rather than its owners.

Looking back at my past post about how much is money one has one must think of it as your net worth. I am currently reading “The Millionaire Next Door” which was a survey made into book by Thomas Stanley & William Danko. It is a survey to find out what are the common factors among America’s millionaires. One topic was about one’s net worth.

The expected net worth formula from “The Millionaire Next Door” is like this:

Age X Gross Annual Income/10

I myself was shock when I computed my expected net worth. My computations resulted to about $ 85,000.00 based on my salary and age but to date I only have twenty something thousand in my name yikes. You might ask me why age becomes a factor in this equation. Age is an important factor because as time passes one should have accumulated that amount of money if you have a fixed amount of income like your salary. It means not only saving money but also earning from that savings. As Bob Proctor said “Money is not meant to be hoarded, it should be circulated.” If you put your money in your bamboo alcansya (Pinoy style piggybank) that amount you expect to have when that piggybank is full is the amount you have dropped in it. Probably it is wise to save but there is also a wiser way to make use of that money. If you are familiar with the parable of the talents you will know why keeping money is wrong.

Likewise you must differentiate spending from circulating money; there’s a thousand kilometer difference between this two. When you spend you let go of the money. When you circulate it means it comes back to you with additional money. Grow money; that what it means to circulate money. Putting it in a bank for 2-3% interest is not that bad, if you have a business plan that you think you can manage well probably putting your money there will be better. Investing on the other hand is for the long term thus it is important for you to know your net worth.

By knowing your net worth you will be able to decide how much do you really have and how much of that you can freely put in a long term investment. If you have time and if you wanna know your expected net worth try the equation above, it will make you think where have you spend all that money that you have earn from your job these past years.