Forget Corporate Balance Sheets, How's Yours?-Minyanville

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Forget Corporate Balance Sheets, How's Yours?

Matt Ford Mar 14, 2008 3:30 pm

Forget Corporate Balance Sheets, How's Yours?


		Calculating assets, liabilities and net worth.

In violent times
You shouldn't have to sell your soul
In black and white
They really really ought to know
--Tears for Fears

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Recently investors have been scrutinizing the balance sheets of firms such as Citigroup (C) and Bear Stearns (BSC). For good reason, too, as balance sheets provide snapshots of financial health.

Ironically, investors often know more about corporate balance sheets than they do about their own. For those seeking better control of their financial future, assembling a personal balance sheet constitutes a worthy step in that direction.

Put together your personal balance sheet by tabulating your assets and liabilities.

Assets

Assets are items of economic value. When listing your assets, start with those that are more easily converted into cash today (a.k.a. current assets). Then, work your way towards longer dated and less liquid assets. For example:

Taxable financial accounts:
Cash (currency, checking, savings, money market accounts)
Fixed income (CD’s, bonds, bond funds)
Equities (stocks, mutual funds, brokerage account equity)

Taxfree financial accounts:
Retirement accounts (IRAs, 401(k)’s, 403(b)’s, etc)

Real estate:
Home
Other real estate

Other assets:
Cash value of life insurance policies
Collectibles (coins, art, other)
Gold/silver bullion
Equity in a business
Stock options
Loans you’ve made to others
Other personal property

Parenthetically, if you’re having trouble understanding what Level III assets are all about and why they’re giving many financial institutions fits right now, then draw a parallel to items listed under ‘other assets’ noted above. Level III assets are essentially illiquid assets that are difficult to value. Since it’s difficult to mark these items to current market prices, the values of assets in this category are estimated using some kind of rule of thumb (a.k.a. mark to model). Simply stated, many financial institutions have grossly overestimated the value of assets in this category and are now finding that they can’t sell them for anywhere near their estimated prices.

Choose wisely what items you admit to your balance sheet assets--particularly those that are 'other' in nature. Values you may be tempted to assign to such esoteric assets as your old baseball card collection or the dining room furniture you inherited from grandma may be way off (and too optimistic). When in doubt, leave them out.

After listing all your assets and their estimated values, total them up.

Liabilities

Liabilities are amounts you owe to others. Essentially, liabilities are debts. When listing liabilities, start with debt that is secured (backed by assets serving as collateral for the loan) and work your way down towards unsecured debt. For example:

Mortgage debt:
Primary mortgage on residence
Second (third) mortgage
Home equity loans

Car loans

School loans

Credit card balances (particularly balances carried beyond one month)

Other loans (e.g., money you owe to friends and family that you plan to pay back)

After listing all your liabilities and their estimated values, total them up.

Net Worth Assessment

Calculate your net worth by taking total assets minus total liabilities. A positive net worth implies that if you liquidated your assets and paid off your liabilities, then something would be left over (a.k.a. equity). A negative net worth means that liquidating your assets wouldn’t cover all your liabilities, which, if liquidation were necessary, creates a condition of insolvency.

While estimating net worth is one useful outcome of the balance sheet exercise, a more powerful consequence for many individuals is a sense of how much leverage is being employed to generate wealth. Divide your total liabilities by either total assets or net worth. The higher the number, the greater the leverage. While leverage can supercharge wealth development when prices are moving in your favor, the process works in reverse when prices move against you. The current Carlyle case is instructive in this regard. When a personal balance sheet is first assembled, the amount of risk evident from the degree of leverage is often an eye opener (I know it was in my case!).

Toddo often ends his missives with a mantra of capital preservation, debt reduction, and financial intelligence as core elements for navigating financial environments. Routinely monitoring your personal balance sheet can help mobilize efforts in this regard.

As they say, what gets measured gets managed.


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