Last week we posted a blog about assets, and what would qualify as an asset. Just in case you missed it, we explained that an asset is essentially anything you own.
In response to that post, we heard from a fair amount of people telling us that they were instructed to make a list of their liabilities after they had listed their assets. They asked us to explain the difference between an asset and a liability. If you, too, are confused by this distinction, we encourage you to keep reading.
First, let’s define what a liability is. A liability is actually very different from an asset. In a way, it is the opposite of an asset. Examining your assets and liabilities against one another is essentially the personal equivalent of looking at a business’s revenue versus expense reports.
To put it even more simply, a liability is any debt or payment you owe to another person or business. Some common liabilities include:
Taking stock of how your assets and liabilities stack up against each other is vitally important for numerous reasons. First, no inclusive and healthy financial picture is complete without this type of evaluation. Anytime you want to consider a significant new investment, such as a house or vehicle, you will want to think about how it will impact the overall asset-to-liability ratio.
Secondly, making these calculations will help your estate planner create an accurate account of your affairs. To ensure that your plans are respected no matter what happens in the future, it is unquestionably important to have a comprehensive understanding of where things stand in the here and now.
You can actually calculate your net worth once you have created your list! The math is simple and straightforward:
Add up the value of your assets
Add up the amount of your liabilities
Subtract your liabilities from your assets
This assessment will tell you if you are already in good shape financially, if you should start investing, or if you need to start saving more.