A well-run business pulls a full set of financial statements every single month. This includes both a profit & loss (income) statement, and a balance sheet.
A profit & loss statement covers a period of time, like a month, or a quarter, or even a whole year. It’s basic formula is that Income minus Expenses equals Net Profit. Its title usually says something like “For the month ending August 31, 2017” or something like that, which tells you all the income and expenses are from that month, so all the net profit belongs to that month.
A balance sheet, on the other hand, is a snapshot; a moment in time, with the numbers on it all being from the same moment. Its title simply has the date, or sometimes, “As at August 31, 2017”.
The formula for the balance sheet is Assets = Liabilities + Net Worth. You can see why it’s called a balance sheet: if you list your assets on one side of the sheet, they have to equal – or balance with – the combined total of your liabilities and net worth.
Remember, Assets are things you own, and Liabilities are debts.
Let’s run an example.
Bob Smith owns his house. He bought it last year for $230,000 and owes $200,000. If he has no other assets or liabilities, his balance sheet will look like this:
See how they *balance*? Magic! J
Of course, the point is to actually find out what your net worth is, so you have to format it a little differently. You can look up the value of your assets and liabilities by your statements, but you have to figure out for yourself what your net worth is.
So you take your total assets, and subtract your total liabilities from them. What’s left? Your net worth. So if we put Bob Smith’s balance sheet into this new format, it will look like this:
The brackets around the mortgage number means that you are subtracting instead of adding, and the double underline under the $30,000 means that you’ve finished adding or subtracting, and this is the final number. That $30,000 is Bob Smith’s net worth.
You’ll sometimes hear someone talking about the ‘bottom line’ in a business; that net worth is the bottom line.
And net worth is the number you want to be increasing, slowly over the years. That’s the number that matters, as your home appreciates and you chisel down your mortgage.
Because if your home appreciates but you constantly increase your debt, your net worth won’t be increasing.
FAQ’s about balance sheets:
What sort of things might be considered assets? What sort of things are liabilities?
It’s important to understand the difference between an asset and a liability. An asset is something you own, but not something you rent. If you buy a car on payment plans, that’s fine, the car is an asset and the amount you owe is a liability.
Your cash on hand is an asset. So is the money in your bank accounts. Any savings bonds you have are assets.
But a credit card or a line-of-credit is a liability. Don’t ever forget that! Some people think that because they have $20,000 available balance on a credit card, they have an asset. Not true! An unused portion of available balance is neither asset nor liability – just a dangerous temptation. But the used portion is a debt, debt, debt! Also known as a liability. As soon as you use your credit card, you have created a liability.
Other liabilities you might have are debts you’ve incurred for medical expenses, anything you’ve borrowed from friends or family, and any outstanding bills.
What value should I put on my house? And should I update that value every month?
House prices can fluctuate a lot, even in a stable market. The spring rush compared to just after Thanksgiving, for example! But it’s actually better not to adjust it too often.
Here’s what you can do:
Go to your county’s website and they’ll usually have a lookup tool where you can put your address in and find your assessed value. Also check out Zillow.com and look at what they say your ‘zestimate’ is.
On your balance sheet, you want to be conservative on how much you list your assets as. The point is not to tickle your ego, but to give you as accurate a picture as you can of your financial snapshot.
Finally, don’t update your home value each month. I would recommend updating it on your balance sheet only once a year, if that. You want to see how much you can nudge that net worth higher, without counting on your home’s appreciation – that way a glitch in the market won’t erase all your gain, and you won’t be tempted when the market is well, to take out your home equity and use it.
Let’s look at a more in-depth example:
Do you see how the double underlines show the end of each section? First of the assets, then of the liabilities, then of the net worth. And the numbers from the assets section and the liabilities section are carried into the column on the right, so that you can easily find the total net worth. Don’t forget to subtract the liabilities!
Now do this for yourself. Download a balance sheet template here, and start filling in the blanks. Don’t worry if this takes you a while to figure out; it will get easier as you get in the habit of doing this every month.
And, yep! You are going to be doing this every month, OK? Remember, the bottom line is the number you want to see trending upwards each month. Don’t stress if you have a month or two where it doesn’t go up, but rather look at the trend over several months.
Please let me know if you have specific questions about writing your own balance sheet! You can email me directly at firstname.lastname@example.org.