How to Calculate your Net Worth
I’m trying to decide whether to open an ISA, the UK’s tax-shielded retirement investment account. To help me make my decision, I took a look at my current net worth and how it’s changed over the past year. In order to do that, I need to calculate my current and previous net worth figures in a way that makes them easier to compare. If it turns out that I’m spending less than I earn, then I’ll go for it.
To do this, I’ll be using what tax accountants call the cash basis. This means that I only care about transactions that involve cash flow. I don’t worry about accumulating income or debt, and I don’t include changes in valuation.
For example, you might have holdings in the stock market. You bought them for a particular price, yet the value that you could sell them for varies as the market moves. To make life easier in comparing two calculations, I’m not going to look at current market value, or realizable value, for any asset.
That’s actually a small lie. I’ve got some Premium Bonds that I paid a certain amount for, that I can access as cash at a week’s notice. I’ll treat this as a cash equivalent, just as though it were an ordinary bank account.
Step 1: Assets
An asset is something that you own, something that you paid for that has lasting value. List all of your bank accounts, savings bonds, etc., and their current balances. If you’re doing this for comparison purposes, you can omit any asset that hasn’t had more cash go in or out over the year.
From an accounting perspective, if anyone owes you money, that too is an asset known as a receivable. For my purpose, even though my landlord owes me a couple hundred for fixing a gas leak, it isn’t going to materially affect the outcome.
Houses and other major assets
I thought about houses as I wrote this, even though I rent. A house is an asset which has a fluctuating market value, from which I want to exclude the influence of a changing market. It also probably has a mortgage, and I do want to include the shrinking balance in my net worth. I’d do this by including it on both sides of the net worth calculation. Once as an asset, at it’s purchase price, and once as a liability (don’t worry, that’s the next section) for the mortgage. That way, I have a stable asset value, but still see the benefit of any overpayments or the downside of any payment holidays.
You could also choose to exclude the mortgage and house altogether on the grounds that the change to your net worth is negligible. Including it, especially if you’re in the first few years of payments, isn’t going to do much other than increase both sides of the equation, assets and liabilities, by about the same very large amount.
Step 2: Liabilities
A liability is something that you owe, a debt. For most people, this will be things like credit card balances, loans, mortgages, and the like. I want to keep this simple, so I’m going to exclude the credit cards that I pay off every month. Yes, it’s a liability, a debt that I’ll be paying very soon. Unless it’s unusually large it doesn’t matter, because I’ll be comparing net worth figures from one year to the next. I can treat this just as though it’s paying by cash, just deferred by a month.
If you are carrying credit card debt, then include the current balances in your list. I’ve got a credit card that’s in a zero-percent interest period, so it has a balance. I’ve included it in my list because it’s a longer-term debt than just month-to-month.
Step 3: Net Worth
In accountancy, there are three categories on a balance sheet. Know it or not, what you’ve just put together is a personal balance sheet. It’s a list of assets and liabilities. To put the balance into balance sheet, accountants use a third category, called equity or capital. For us this just means taking the total assets and subtracting the total liabilities.
If it’s positive, congratulations!, you’ve got some savings. If it’s negative, then you’re in debt, sorry.
I’ve got a spreadsheet that I use to calculate all of this, and if anyone’s interested I’ll sanitize it and post it.