I wrote a blog in the spring about cash flow (income minus expenses) and explained a simple way to figure out what you spend every year. However, another equally important number to know about in your financial picture is your Net Worth. You should always ensure that it’s moving in the right direction!
These days, with easy access to revolving credit, it’s too easy to overspend. Gone are the days when the bank account at zero meant no more money until pay day. To avoid digging ourselves into holes financially we need to take stock of our net worth every so often.
When you subtract everything you owe (liabilities) from everything you own (assets) you are left with your Net Worth. Makes sense, right? Funny enough, this number is usually quite different from your actual financial worth. Why? There are a few reasons for this but the big one is the deferred tax bill associated with certain assets like RRSPs, RRIFs, equity investments and real estate (other than your primary residence which receives an exemption when sold). These assets grow tax free until they are sold, then the taxes become payable. There are also brokerage and legal fees associated with selling a property.
So, if Net Worth isn’t an accurate depiction of your true financial worth, then why bother with it at all?
We bother because it is a great tool for tracking progress towards financial goals. Is your net worth increasing every year? Fast enough to get you the retirement you want? If your Net Worth is decreasing, or not increasing at the right pace, you are most likely overspending. This is why cash flow and net worth go hand in hand. To reach your financial goals you need to increase your net worth and to increase your net worth you need to have surplus cash flow. With these two things under control you will be well on your way to financial freedom.