Net worth is the way that most people determine their wealth. It is a good indicator of your wealth but it is far from the only one. It is important that you not focus exclusively on your net worth when you are looking at your finances because there are other things that you need to consider. Net worth will tell you how much you have today but not how much you are spending so it can’t really tell you if you are heading for trouble.
Your net worth is simply your assets minus your liabilities; it is an indicator of your financial position. Most people tend to focus on their net worth as a way to determine how good their financial situation is. This isn’t necessarily the best way to do it; usually it makes more sense to focus on cash flow. That being said cash flow doesn’t really account for your debts so by itself it can’t give you a complete picture.
Therefore the best option is to use both your net worth and your cash flow together to assess your situation. Net worth will show you where you are today while your cash flow will help you see where you are headed in the future. Determining your net worth is a fairly easy process but there are some pitfalls that you are going to want to avoid. To calculate your net worth all you have to do is add up your assets and your liabilities and subtract your liabilities from your assets.
The biggest problem is to actually determine the value of your assets since they don’t all have a clearly defined cash value. You are going to have to estimate the value of things like your house, most people tend to overestimate. This may make you feel better but it doesn’t give you an accurate picture. It would make more sense to be very conservative in your estimates.
The other common mistake is to fail to include all of your liabilities most people owe more money than they actually realize; it is easy to forget some of these debts. Subtracting your liabilities from your assets will give you your net worth. If this turns out to be a negative number you have a problem, you owe more than you have. Unfortunately a lot of people find themselves in this position, mainly because of credit card debt.
If you do have a negative net worth you are going to have to make changes in your life style because things are only going to get worse. Even if you have a high net worth you may be headed for trouble which is why you also need to look at your cash flow statement. If you are spending more than you are making you will soon see a decrease in your net worth and it can happen quickly. It pays to be vigilant when it comes to your finances.