People often think that the only way to accumulate wealth is to be frugal and make lots of sacrifices. However, accumulating wealth doesn’t always demand that you live a sparse life; rather, it requires that you use what you have efficiently (waste less) and spend less than you earn (save more). The path to reaching your financial goals starts with understanding how best to put your assets to work for you.
Snapshot of Your Financial Health
In order to know where you are going, you must first know where you are. Open any trip planning software and it will ask you two basic questions… where you are starting and where you are going. Once you establish this information the “app” will tell you how to get there and how long it will take.
The same is true for your finances. You must know where you are now and where you plan on going. Once you’ve established this you can begin planning the route you need to take to get there. First, you need to determine where you are financially. To accomplish this, create a spreadsheet that covers four categories: assets (how much you own), debt(how much you owe), income (what you earn), and expenses (what you spend).
Net Worth
Your “net worth” is simply your assets minus your liabilities (how much you have and how much you owe). It’is important to note that you should use the liquidation value of your assets (garage sale prices), and not the price that you paid. Likewise, you should use the balance you owe on any loans not the amount you borrowed. This exercise is to determine the amount of money that you would have remaining if you sold all of your possessions and paid off all of your debt. This simply shows how rich you are. If the number is negative that is “not good” and you have a negative net worth i.e. you owe more than you own. If you own a house you can look on a site like Zillow.com to get an estimate of how much your house is worth. Kbb.com will tell you how much your car is worth.
For example:
| Assets: | Liabilities: | |||
| House | $200,000 | Mortgage | $175,000 | |
| Car | $10,000 | Car Loan | $5,000 | |
| Bank | $2,500 | Student Loan | $19,000 | |
| Stocks | $1,250 | |||
| Furniture | $2,500 | |||
| Computer | $400 | |||
| Misc. | $800 | |||
| $217,450 | Total | $199,000 |
Net Worth = Assets – Liabilities
Net Worth = $217,450 – $199,000 = $18,000
If you have a positive net worth and a “positive cash flow”, you should see your assets growing month after month.
Cash Flow
Your cash flow is determined by subtracting all your monthly expenses from your income. Some people are afraid to look at what they are spending every month because they don’t want to know how fast they are falling. If you don’t do that, before long you will be in big trouble. It is better to know how bad it is and take steps to correct it than to play ostrich and end up getting eaten by a lion.
As long as your monthly income exceeds your monthly “out-go” you are doing fine. If not you need to adjust something.
Understanding Net Worth and Cash Flow
Your Net worth gives a snapshot in time of where you stand financially. If you are fresh out of college it is very likely that net worth will be negative since you haven’t started building assets yet. Don’t worry too much just start building slowly and watch your expenses closely. By tracking your net worth on a regular basis in your spreadsheet and keeping the record your net worth also works like a score card, if your net worth is decreasing over time that is a flashing yellow light. If it is growing over time it is giving you the “thumbs up”. Banks also look at your net worth and cash flow to determine your borrowing capacity.
Cash flow tells you how much discretionary cash is available on a monthly basis. If your net income (after taxes etc.) is $3,000 a month and your expenses (including savings for emergencies and annual expenses) are $2,800 that means you have $200 to use toward wealth accumulation.
Positive cash flow allows you to reinvest in yourself, dollar cost average in the stock market, or take advantage of other opportunities that may arise. You don’t need a master’s in financial economics to determine which project offers the highest possible return but if the topic is of interest to you it is certainly worth pursuing.
Once you have accumulated a few assets, looking at your net worth regularly offers the opportunity to examine the return that you are earning on each asset and decide whether you can do better elsewhere. If so, you may consider selling the asset and putting the cash in another investment that will work harder for you.
Time is of the Essence
Procrastination is the enemy of wealth accumulation. Once you create a plan, put it in motion. Reevaluate your situation regularly and make adjustments as necessary. Over time, your net worth will grow and reinvested gains, and compounding returns, will create a snowball effect that will grow your assets exponentially.
Bio: Rachelle Wilber is a freelance writer living in the San Diego, California area. She graduated from San Diego State University with her Bachelor’s Degree in Journalism and Media Studies. She tries to find an interest in all topics and themes, which prompts her writing. When she isn’t on her porch writing in the sun, you can find her shopping, at the beach, or at the gym. Follow her on Twitter and Facebook: @RachelleWilber; https://www.facebook.com/profile.php?id=100009221637700