In a recent discussion with a friend, he complained that his accountant had not prepared his personal balance sheet properly; his net worth had taken a nose dive with a huge decline in his net assets.
This is what I want to discuss with you today.
This had upset the man to the extent he felt that his accountant must have either omitted something or had not put the correct values of what he owned while preparing the personal balance sheet.
I thought about this scenario, wondering if only I could get a chance to look at the said personal balance sheet and try to understand what my friend was complaining about. And since I had prepared many personal balance sheets before, this matter became quite interesting to me. Who makes an individual’s personal balance sheet? Why should a personal balance sheet decline in value! Does it mean, the balance sheet value should only head one way, upwards?
That’s what made me think of writing this piece and share with many of the readers about this highly misconstrued issue of the personal balance sheets, a requirement when one is borrowing funds from many financiers, and in which the accountant is sometimes blamed for the wrong reasons. An accountant, in truth does not make your personal balance sheet! Rather you make your personal balance sheet. It’s that simple. The accountant only assists in making it more presentable by using the knowledge and skills that he has acquired. After all that’s what he has been trained to do.
In other words you are the designer of your own personal balance sheet.
Every moment, every hour, every day, doing or not doing anything, eating or not eating, sleeping or awake, you continue making your personal balance sheet.
To put it simply a personal balance sheet is a summary of your assets on one hand and your liabilities on the other. The difference between the sum total of the assets and your total liabilities is your net worth. This difference can either be positive or negative. Positive means that you are worth that much but negative means that you owe more than you own.
Every time you buy an asset, say a fixed asset, you either buy it on cash or on credit basis. Assuming you buy it on cash basis. Maybe you will go to the bank and withdraw some cash to buy what you have planned. As a result, your cash balance goes down and your assets level increases, depending of course on what you have bought. It is like moving your money from the left pocket to the right pocket. You cannot say you are any richer by that!
On the other hand when you buy an asset on credit two things increases. Your asset increases as well as your liability. As you continue paying for your liability, ceteris paribus, your assets level continue to rise. This is especially so when you buy an asset that increases in value with the passage of time.
Let us be a bit more practical. Imagine that you have bought a piece of land on credit by borrowing from your Sacco, or through your bank. You now have the land which is
But how can one explain the meaning of net worth in simpler terms. It means that if you were to sell all your assets and clear all your liabilities what you remain with is your wealth, the net worth.
When you spend cash on personal expenses like entertainment or non-essential items there is no increase in the balance sheet. This reduces your cash position which in the meantime will be reducing and not building your balance sheet, and your net worth declines. This means to grow your personal balance sheet you have to keep growing your assets.
There are various reasons that may lead to the decline in your net worth.
When you invest in risky projects and which lowers your returns or the projects fail all together, the net effect is that your net worth will decline accordingly. Also, when you sell off your assets to finance consumption without growing your assets (a recipe for trouble) then your net worth quickly declines. This also declines when you purchase an asset that declines in value such as a car or some furniture.
Every time you prepare your personal balance sheet ensure that you take into account the increase in such assets as buildings and land, the investment assets, jewellery, stock and bonds. Have them valued. You do not have to be complex, current market prices can give you a guide to the value of your assets as long as it is sellable in an open market. Let the best value of the assets you own be known by you so that you are able to know the direction to which you are going.
On a similar vein make sure that your assets that decrease in value e.g. vehicles you have captured the correct value so that you do not overvalue or overstate your personal balance sheet. Remember the last person you should cheat is yourself!
Further preparation of the personal balance is a very important activity and worth doing regularly. This way you will keep a tab on your investments and would be encouraged to keep growing if you already know where you are and what you are worth.
I hope that this does explain to you the reader about the value of that which you love. Money’s worth. This I believe would enable you to prepare as often as you can your personal balance sheet.