Defining Net Worth?
Have you ever heard of the term richest man alive? How do you think that out of all the people in the world, we are able to identify the richest man in the world? Although some might believe that it is your total income that makes you the richest man, it is the net worth that decides where you stand financially.
Net worth is simply the subtraction of all your assets from your total liabilities. Hence, in theory, the richest man would be the person having the most considerable assets to liabilities difference.
However, net worth is not a tool only for the rich. You, too, can calculate your net worth for your evaluation and improvement of financial health. In fact, calculating net worth is one of the few habits of highly accomplished people. Therefore, it is a good idea for you to adopt this habit and benefit from it.
Calculating net worth is quite simple. All you have to do is add all your assets and liabilities. After you’ve done that, merely subtracting your assets from liabilities will give you the figure for your net worth.
But that’s not where it all ends. Just calculating your net worth won’t be a perfect measure of your financial health. The concept of Liquid net worth, a seemingly smaller subset, is even more important than net worth itself. For that, we need to categorize both our assets and our liabilities. This makes the process a little tricky, but all the more rewarding for you.
Although many applications and soft wares do exist that can calculate your net worth for you, you can also calculate your net worth and your liquid net worth yourself by following a few simple steps.
Steps to Calculate Your Net Worth
After briefly discussing net worth and its importance, we can now start focusing on how to calculate your net worth in a step by step process.
The process of calculating is also divided into two parts; 1) Calculating Assets and 2) Calculating Liabilities since these are the two main components of Net Worth. Let’s first discuss the steps to calculate your assets accurately.
First of all, we should know the difference between liquid assets and non-liquid assets. Liquid assets are those that can be converted into cash quickly, while non-liquid assets are those that you can’t sell instantly. To clarify, let’s take a look at a few examples of liquid and non-liquid assets. Your pocket money, your cell phone, and all your savings in your bank that you can extract when you want are all examples of liquid assets. While non-liquid assets can be your belongings that will take more time to sell or the belongings that you wouldn’t want to sell instantly. A simple example can be that of your house or any land that you own. Having discussed the categorization, now we can begin describing the few simple steps to calculate your assets.
Step 1: Here, you should focus on calculating your major assets, such as the value of your house, car, and other similar properties that you own. These types of assets are defined as noncurrent assets, or in simple words, assets that cannot be converted into cash instantly. Hence they will not be categorized as your liquid net worth. However, these assets do have the most value that you can own, and thus, it is a good idea to know the value of these assets.
To gauge an idea, first, you should start categorizing all the assets as 1) Major and 2) Minor. Having done that, consider having an expert calculate the market price of all the major assets that you own. This will give you a rough estimate of the value of your major assets.
Step 2: Next, you should calculate the value of your minor assets, the second part of your categorization. These assets can either be converted into cash fast or are already in cash form. This is the first step to estimate the liquid net worth you have.
Some examples of liquid assets can be your cash in the bank, money in the wallet, cheques, bonds, and all the assets you consider liquid. These assets, since they are already in cash form, are easy to calculate. Try calculating these assets on your own or have an expert calculate it for you. In either case, calculating your liquid net worth is quite essential, and calculating your liquid assets is the first step in doing so.
Step 3: There might be assets that you find hard to categorize in any of the above categories. Since not everyone is of a finance background, it is quite possible for you to have trouble classifying your assets. Hence, it’s always a good idea to have the “Other Assets” category to compensate for such possessions.
Step 4: The next step is to add the above values that you have calculated. This will give you an overall figure of your assets that you own, both major and minor.
Step 5: The last step is to underestimate the value that you have calculated. This is important because, even though a high net worth might look good, it will not be the actual value that you own. And so, you should underestimate the total value to compensate for any errors.
Calculating Your Liabilities
The next step is to calculate your liabilities, both major and minor. Like assets, these are also categorized into liquid and non-liquid debts. Here, liquid liabilities will be the short term loans, money that you owe any friends or family, and all other small payments that you can pay within a year. On the other hand, non-liquid assets consist of long term loans, mortgages, and other such debts that you can’t pay within a year.
Step 1: Like in assets, you should start by calculating all the major liabilities that you currently have. Hence, the first step involves calculating the non-liquid liabilities that you owe. Just like the examples above, these can be your long term loans, deferred payments, and considerably larger sums of debts.
Step 2: The next step is to calculate your liquid liabilities or short term loans that you owe. This is the second step of calculating your Liquid Net Worth. These liabilities involve the smaller amounts of money that you may owe your friends, family, or even colleagues. They can also be the interest payments that you pay monthly on your long term loans
Step 3: This step, again, involves the “Other liabilities” category as it is essential for the same reasons we have discussed above. You can add any liabilities that you find hard to categorize in this category.
Step 4: After calculating all your liabilities, you can now add them to calculate the total liabilities that you own. For people who are still at the beginning of their careers, it is entirely reasonable to have a high value for liabilities.
Step 5: You might remember that after calculating total assets, we underestimated its value to be more realistic. Now, in this case, you should consider overestimating your liabilities as the chances of an error always exist. Like in the case of assets, this will help you gain a closer estimate to the actual value of your liabilities.
The last step, as we discussed in the very beginning, is to simply subtract the value of assets from the value of liabilities. The resulted value will be the total net worth that you have. Having calculated your net worth, now it is time to reap its benefits. Below are some ways you can use and increase your freshly estimated net worth.
Net worth gives you an idea of where you stand. You should consider calculating net worth every year and compare it with previous estimations. This is exactly why it was important to underestimate your assets and overestimate your liabilities as it gives you the motivation for continuous improvement.
Increasing Liquid Net Worth
Earlier, we have discussed the components of liquid net worth, i.e., liquid assets and liquid liabilities. The step for calculating liquid net worth is to simply subtract the former from the latter. Liquid net worth is crucial as it defines your ability to pay off your short term debts quickly. So, if you have an overall negative net worth but a positive liquid net worth, you are still surfacing on the safer side of your financial life.
Consider Investing from Liquid Assets
If you have a positive value for liquid net worth, you should consider using your excess cash in different investments. This will help you further enhance your liquid net worth and help you pay off your major liabilities sooner than later.
Therefore, net worth is an important habit that you can develop to calculate and increase your net worth. You can follow the steps mentioned above or develop your own for assessing your assets and liabilities. The essential take away from this article is the importance of liquid net worth, especially for students or fresh grads that are still in the process of building their financial value. Once mastered, this simple habit can achieve wonders for you and your financial health. This will teach you exactly how you, too, can make your way towards becoming the richest man in the world!