This is another staple of personal finance, and yet is highly overlooked by everybody that isn’t a banker, accountant, or wealthy. I’ll tell you about what it looks like, and define the two categories it contains in a much easier way than you would find in an accountant’s dictionary. That way, you can draw up your own balance sheet, and be assured that you’re putting everything in the right place for particular instances. It makes more sense to do it one way when you’re looking at it for personal knowledge of your net worth, and it makes more sense to do it a different way when you’re applying for a bank loan. I’ll explain the differences. You’ll benefit from it.
What It Looks Like
In its most basic form, a balance sheet is a sheet of paper with a line down the middle, the left marked “Assets” and the right marked “Liabilities”. There is a myth perpetuated by accountants and accounting classes that says that a balance sheet must balance. This is wrong. No, don’t leave yet, accountants, let me explain myself. Accountants are trained to do business balance sheets, and pay no real attention to personal balance sheets. On a business balance sheet, the Assets column will always equal the Liabilities column.
This cannot be true of a personal balance sheet. The reason is because for everything that the business owns, if it doesn’t owe anyone else on that value, it owes it to the business owner . This is not true for a personal balance sheet, and thus, the personal balance sheet only balances with respect to other balance sheets . That means that on a personal balance sheet, your assets are in someone else’s liability column, and your liabilities are in someone else’s asset column. Don’t worry, you don’t need to know whose is what quite yet, lets take a look at the Asset column.
Assets are different, depending upon who you ask. The simplest explanation is that assets are anything that puts money in your pocket. Stocks, bonds, mutual funds, real estate, businesses and intellectual properties can all be assets. However, they can also all be liabilities. Just use cash flow as your guide. If it’s putting money in your pocket through dividends or rent or royalties, or you got it well below market value and can sell it for much higher than you paid at any time , it’s an asset. If you’re wearing it, it’s not an asset. If you’re driving it, it’s not an asset, with the exception of taxi and limo drivers. If you live in it, it’s not an asset .
These are important points to remember when you’re making a personal balance statement for yourself. If you’re going to the bank for a loan, however, put all the cars, houses, Armani suits and $500 golf clubs you can. They’ll pretend that those are all assets, and consider you much more highly for a loan. But for use in keeping track of your personal wealth, those are all no nos.
The liabilities column is next. For most people in todays world, this is probably your larger column. In here go all your loans of any sort (student, mortgage, consumer credit, car, etc.). In addition to your loans, the other things that go here are anything that takes money out of your pocket every month. That means your car, your house, any real estate investments you have that are making less than they cost you, and any businesses which are making less than they are costing you.
The reason this column virtually never equals the asset column in personal balance sheets is due to the fact that most of your personal liabilities go for something you can’t put on the asset column.
*Student loans can’t be balanced because the value of your education is incalculable.
*Consumer credit can’t be balanced because what you bought with it is virtually worthless.
*Your mortgage can’t be balanced because the value of your house is not calculable until you attempt to sell it.
*A car loan can’t be balanced because cars lose massive amounts of value when driven off the lot, and are always worth less than any loan amount.
So, remember, assets put money in your pocket, liabilities take money from you. This should be enough to help you make your own personal balance sheet. So go ahead and do it while you’re thinking about it. It is important to your financial future.