Knowing your number is half the battle. If you are able to calculate your net worth position (the difference between the things you own vs. amounts you owe) or you are able to refer to a previous periodic net worth statement, consider yourself ahead of the pack. Those graduating high school (pre-student loan application) without credit card debt should embrace their potential. Although their net worth might not be substantial, it most likely will be positive.
Considering the average household debt, many Canadians are currently living with a negative net worth position. Unfortunately, thousands of homeowners are living with negative equity, especially those whose property value decreased over the years (decreasing at a greater amount than the total mortgage payments). Even worse, there are thousands, if not, millions of Canadians that currently are unaware that they have a negative net worth position.
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The key to attaining wealth is to treat your personal finances as if it were a business. All successful businesses review their financial statements periodically (monthly, quarterly, and annually). The review process, of a company’s historical performance, by most business owners is through two statements:
1) Income Statement including Statement of Retained Earnings
The Income Statement is a summary totalling income generated versus the operational and general expenses consumed over a set period. The net result determines how much income is taxable (after qualified expenses have been deducted). If the statement produces a negative amount, then the business can apply this credit to previous or future returns; however, if it is positive they will have to pay corporate taxes as well business owners can determine how they wish to spend/ allocate their retained earnings.
Similar to corporate tax returns, millions of Canadians partake every year in submitting their personal tax returns that encompasses the same exact process. Instead of business income, there is employment income (T4 statements), and some individuals may have investment/ trust income (T3 and T5 statements); however, an individual may have business income as well from their home based business. Depending on the employer, an individual’s tax liability should be addressed and covered every pay period. Individuals should be aware of their tax liabilities throughout the year to ensure their source deductions are correctly calculated.
Assuming an individual has a stable income source with a reliable employer, profits from their personal income statement could be acknowledged monthly where they may decide how to spend their retained earnings on, such as:
- Paying down debts
- Starting an emergency fund
- Savings for long-term savings
- Paying down their mortgage quicker
- Pursuing life long dreams
- Spend the surplus on entertainment
If you constantly find yourself with net losses than you may want to consider the following:
- Could it be possible to generate more income?
- Where could you save some money? Which expense is not needed?
- Are you constantly owing the government every tax return? Who is responsible?
Periodic reviews are highly recommended, as monthly would be ideal; however, quarterly (every three months) is also effective.
An example of a personal income statement:
2) Balance Sheet
By now you should be familiar with the accounts that make up a Balance Sheet. Remember the net worth calculator? When calculating your net worth, you are entering all of the balances (amounts owed and owned), on a specific date, that represents your personal Balance Sheet.
Businesses use balance sheets to determine their equity position, to assess their ability to attain additional financing, to manage their cash position, as well to value the company to bring on new investors or to sell the company. A Balance Sheet has two equal columns: 1) Assets on the left (amounts owned) 2) Liabilities (amounts owed) and Owner’s Equity (net balance of amounts owned and owed) on the Right. The greater the owner’s equity the greater the possibilities to partake in opportunities to grow. The same applies to an individual’s net worth position on their personal balance sheet.
An example of a personal balance sheet:
The Path to Accumulating Wealth
Wealth accumulation for most individuals starts with the Income Statement. The route to wealth is by positioning oneself with the ability to build a reserve of cash to partake in investment opportunities and/or afford the time necessary to create a business model without incurring consumer debt.
As an individual retains their earnings, they will have the opportunity to purchase assets, as assets increase in value so does the net worth (assuming scheduled loan payments are made, if any, on the asset financing). Potentially some assets eventually generate cash flow (i.e. rent rooms out of a house, dividends and interest income from investment portfolio, royalties, etc.) that could cover debt obligations (liabilities) and even monthly expenses.
If an individual’s assets produces enough cash flow to cover their debt payments and everyday expenses, they would have the option to choose whether they wish to work or not, have the freedom to choice what type of work or pursue passion projects. If they do chose to continue working, the income generated could be used to solidify their financial position as well afford additional luxuries in their everyday life by continuing the same cycle as before.