The net worth of an individual is nothing but the difference between assets and liabilities occurring in his finances. If the assets held by an individual are greater than the liabilities, he will have a positive net worth and vice versa. Calculating net worth is easier than it looks. The most important aspect is that it gives a summary of your financial health in an instance. Once you know your financial health, you will be able to determine how to put it in an optimal state and/or how to maintain it. This is why calculating net worth is important.
Let’s see how net worth can be an important aspect of personal finance.
Practically indicates when you can retire
The question that all personal finance answers point to, but no one knows exactly. Although one way to find it in absolute terms is to weigh the question of net worth. For example, there is a couple who earn Rs 20 LPA and have assets worth Rs 1.2 crore. Now, the same couple also have a debt of Rs 50 Lakh as of the date of calculation. The net worth of the couple here will come to Rs 70 Lakh (1.2 cr – 50 lakhs), which is positive but does that mean the couple can retire? The debt of Rs 50 Lakh is repaid by considerable EMIs, which are supported by the annual income of Rs 20 LPA. Therefore, if the couple decides to retire, they can no longer afford the EMIs, so they will have to cash in all the assets and pay the debt. After that, they will be left with Rs 70 Lakh without any assets, which may or may not be considered enough to retire.
Realign your goals
A negative net worth doesn’t have to be rocket science to realize that your financial health needs a saline solution. It’s like using a mobile GPS: once you know where you are and have a brief idea of where you want to go, finding the route can be easy. Also, even if your net worth is positive, you may have taken a wrong turn to reach your destination. In such cases, calculating net worth helps you change your saving, investing, and spending habits to realign them with your financial goals.
A look at assets from another angle
Debt is something you owe, while assets are something you own. But the definition of assets and liabilities in net worth goes beyond that. Debt can be categorized as long-term or short-term, but ultimately both must be paid. The important categorization is that of assets, which can be current or non-current assets. Current assets can be converted into cash in a minimum of time, unlike non-current assets. For better understanding, here is an example of a person holding a non-current asset worth one million rupees, which at first glance seems sufficient for retirement, debt-free. However, if such an asset is your home, which may not generate income now or in the future, such an asset may not be entirely useful and your retirement may not depend on it. Net worth helps you understand assets and liabilities from a different perspective. It differentiates assets in a way that helps you identify assets that can generate income for the future.
Better net worth equals a longer credit period
Heard the name called CIBIL score? Net worth is not too far off from this and, in fact, can give more accurate information than CIBIL. Net worth in simple terms indicates the value of an individual. So, a positive net worth can get you better loan deals from banks. But this positive net worth will be after taking into consideration the contingent loan. The reason is that the difference between assets and liabilities may not be large enough, which may result in negative net worth after borrowing. Banks and lenders take a closer look at your net worth, and when funds are needed, negative net worth can hurt you.
Net worth is not a financial statement, it is an eye opener that can help you make better financial decisions.
(Viral Bhatt is the founder of Money Mantra – a personal solutions company)
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