Personal Balance Sheet – Step 2

We can argue about whether the personal balance sheet or income statement is more important in the journey to financial independence. I’ve seen this debated online in the past and people have strong opinions on both sides.  I personally believe it depends on how far down the path to financial independence you currently find yourself.

Your income statement will matter more in the earlier stages and your investments will matter more in the later stages.  In reality, both financial statements matter a lot and are interrelated throughout your life. Either way you need a personal balance sheet, so let’s set one up.

A personal balance sheet?

Wait… I want to start at the beginning.
Link to the previous step – Step 1: Transactions

Do you already have a full balance sheet you update each month or quarter?

If you do that is fantastic and if you don’t, keep reading. I’m reviewing how to build a personal balance sheet from the account balances gathered in the prior step first because it is easier to fill out and understand than the income statement.

Keep it simple

Balance sheets can be particularly complicated financial statements for corporations or a small business but should be relatively simple for an individual household.  I say it should be less complicated because most of us won’t have numerous accounts of any type or the need for accruals, amortized expenses, or other accounting concepts.  It should just be a listing of your month-end balances grouped together by type and placed in the proper order.

What is on a personal balance sheet?

A personal balance sheet has three main parts: assets, liabilities, and net worth.  Those main categories are usually subdivided to show the accounts in a logical manner and to make updating the spreadsheet easy each month.

• Personal Balance Sheet Order
  • Assets
    • Cash accounts
    • Investment accounts
    • Retirement accounts
    • Physical assets
  • Liabilities
    • Loans *
      • Mortgage
      • Car loans
      • Student loans
      • Credit cards
    • Known future expenses
    • Other liabilities
  • Equity (Net Worth)
    • This is a calculation = Total Assets – Total Liabilities
  • Total Liabilities & Equity
    • This is a calculation = Total Liabilities + Net Worth

A quick note on the loans

The loans should be placed in the following order: Mortgage, loans under 4% interest rate, loans with 4-8% interest rate, then loans with 8%+ interest rates sorted by larger loan balance first if more than one exists in the category.  This isn’t strictly necessary at this point but will certainly help us when we get to our plan to pay down debt later on in the plan.

As you can see, the assets are all of your cash and investment accounts added to the value of your physical property (home, car, property, and other sellable items).  The liabilities are all of the debts you currently have like a mortgage or car loan.  Additionally, you could include known future expenses here you are saving up for like replacing the roof on your house.  If you know that a $10,000 expense is due in a couple of months, it makes sense to add it as a liability now to not inflate your net worth and keep yourself in check on the amount of cash you have on hand.

Net Worth = Assets – Liabilities

Your net worth is simply the sum of all your assets minus the sum of all your liabilities.  Think of this as what you would have leftover if you decided to cash out all your accounts today, sell all of your belongings, and pay off all of your creditors.  It may not be positive right now and that is ok… more than ok honestly.  Our net worth was certainly not positive when we met and got married, but we made a plan and worked our way out of the proverbial hole to a positive net worth.

Net worth is important in financial literacy because it is a solid measure of progress on the journey to financial independence.  We often view people who live in large houses, drive nice cars, wear nice clothes, vacation often, and generally live lavish lifestyles as being wealthy because they are displaying outward signs of wealth.  Those people could legitimately be wealthy but they could also be overextended and “house poor” where they look wealthy but have very low or negative net worth because of the amount of debt they are in to sustain such a lifestyle.  The net worth paints a more complete picture of your financial situation than seeing just your investment or asset balances alone.

Just track your personal balance sheet

Personally, the main downside to tracking and knowing your personal balance sheet is the slow rate of progress at the beginning. The progress made on the balance sheet will be slow as you ramp up your savings rate and side hustles.  The growth on this side of the equation will be exponential as each successive growth builds on the previous ones to compound over time. This will accelerate the net worth increases later on in your path to financial independence.  Just know that this path works, and works well, but might take patience on your part while the engine builds steam.

That said, the upside to tracking and knowing your personal balance sheet numbers is to feel a measure of control in your life that is often hard to come by.  Everyday life is so complex and volatile, it is nice to know where you stand financially at any given time. It is reassuring to see, in concrete numbers, your progress toward financial freedom. 

Apologies for this…

I would always prefer to know exactly where I stand, good or bad because knowing is half the battle. Yes… I just made a G.I. Joe reference.  I’m a millennial, that’s what we do.

Good work on setting up a personal balance sheet

Link to the next step – Your Income Statement