Assets, Liabilities, Cash Flow & Net Worth
How they all work together in building a secure financial plan for you and your family.
What an exciting topic right! I know, I know…probably not so much. But here’s what I do know — if you don’t take the time to understand the basics of Assets, Liabilities, cash flow and net worth, and how they work, it will hurt you financially.
Each and every one of us whether we like it or not are affected in one way or another by them. And those who take the time to study, and learn how to manage their assets and liabilities will be able to turn them into much higher cash flow and greater net worth.
Now trust me…that last part is something you CAN and SHOULD get excited about!!
I’ve taken entire semesters at University that touched on this subject and we barely scratched the surface of each one of these topics let alone fully understanding them. So it’s crazy to think that we can go over everything in great detail in a short article.
However, on a personal level, since finances have always been a passion of mine to learn more, I’ve read hundreds of books, listened to thousands of audios, attended countless seminars and been mentored by experts on the subject for the better part of a decade plus.
So even though I’m not a certified financial advisor or so-called ‘’expert’’ on the subject, I feel I’ve developed a good understanding of these specific topics and my goal today is to take all of this information that could seem complex on the surface, and make it simpler and more relatable to the average person who doesn’t want to be an accountant or financial planner.
So for this article, we will look at each of the topics individually, explain what they are and how they relate to your everyday life.
Then I’ll wrap things up with a few simple tips on how to make them your friend and work for you in a positive way.
The definition of assets is something valuable that an entity owns, benefits from or has use of in generating income.
Basically, something you own that has value.
There are many different kinds of assets and especially if you start talking in accounting or financial terms, the list and categories start to get very long and complicated.
I’m not trying to give you an accounting degree here so the most simple breakdown would be in 2 categories of assets…which are called Tangible and Intangible.
The major difference between the 2 would be this:
Tangible assets are physical in nature while intangible assets are non-physical in nature.
Some examples of Tangible assets would be cash, or property such as a house, commercial building, camp, land. Vehicles, tools, electronics equipment boats, furniture, collectibles, jewelry, and art.
These are all assets that you could sell in exchange or trade for something else of value or cash and are again physical in nature.
Intangible assets would be more along the lines of a trademark, a patent, brand name, network, list of clients, a song, manuscript, royalties or an invention.
It’s harder to put a value on it as it’s not as tangible. There isn’t anything physical in nature but it has a lot more to do with intellectual property.
However, these can and often are the most valuable, and for someone who might be starting with very little in terms of physical riches probably has a better chance of actually creating wealth through intangible assets at first.
By first using their imagination, creativity, and talents to build intangible assets that don’t take as much money to create if any at all…and later turn that wealth into other physical assets afterward.
In the 1990s Michael Jordan was the arguably the best basketball player on the planet and one, if not the best and most recognized athlete at the time.
He then used that intangible asset (his talent for basketball) which is not something he could sell to someone else, he had to use it to make it count and get paid as an athlete….but he turned himself into a brand and revolutionized how athlete marketed themselves as a brand.
Think of Nike…Air Jordan’s, Gatorade, McDonald's. All companies that used the Jordan brand to promote their own products and it worked.
The Jordan Brand was worth a lot more as a marketing asset than his actual basketball talent. But it’s his initial Basketball talent as an asset that was then turned into a bigger asset in the end.
A friend of mine writes jingles, and then gets royalties on them every time someone uses them in an advertisement or movie.
Take music, for example, more often than not, the songwriters get wealthier than the actual singers as they can write for multiple artists. So even when an artist goes ‘’out of style’’ he can still keep on writing songs for new ones.
So to recap, Assets are either tangible or intangible and something of value.
The definition of liabilities is an obligation to or something you owe to somebody else.
In essence, a liability is an IOU.
In accounting terms, there are 3 types of Liabilities:
1. Current: Bills payable, short term loans, bank overdraft, income taxes payable, interest
2. Non-current: Mortgage, long term notes payable, leases
3. Contingent: May or may not happen — Lawsuits, product warranties, possible future bonuses commission owed.
Individuals who accumulate too much liabilities, IOU — or in other terms — Debt, will see their credit score affected negatively, their ability to borrow decrease, their cost of living goes up, and typically bad things will start to happen all the way to eventually bankruptcy which is essentially a point of insolvency.
Basically, even if you sold everything and keep working, you still couldn’t pay back what you owe.
Here’s a quick exercise you can do to help understand this:
On a piece of paper, write on the top left side ASSETS and on the right side write LIABILITIES.
Then draw a line straight down the middle.
Under ASSETS you want to put anything that you own that has resale value and add a $ price to it.
Now be fair, your favorite poster or childhood teddy bear may have sentimental value to you, but unless it’s a collectible item and in great shape, it probably doesn’t have a high resale value.
A good way to evaluate what your ‘’stuff’’ is really worth it to check out second-hand sites like craigslist, eBay, Kijiji and many more. It will give you a good idea.
Just because you paid $500 for your favorite video game console 6 months ago, doesn’t mean the market will be willing to pay you that much for it today, so try to be as accurate as possible.
You might say Charles…I’m 18 or 19 or 20 I don’t really have any assets. The truth is you probably have more than you think.
Even if you don’t own a house or car yet, you probably have some electronics, collectibles, art, record collection, maybe a bike, or books, sports gear, etc.
If you have more such as a house, investment portfolio, precious metal, equipment, add all of those up as well. Any cash you have in your current bank account counts also. Add all of those on the 1 side of the page.
On the other side put everything and anything you owe.
This could be a personal loan you made to a family member, a bank or lender.
A credit card balance or phone bill outstanding. Tuition, rent, insurance or car payment if you have one.
Taxes owed on a property or income taxes.
Again, add all those numbers up on the right side of the ledger.
When you take all your assets together and add up the dollar value of each of them together you will get a total number., Then do the same thing on the other side and add all your liabilities so you also have a total dollar value of what you owe. Finally, subtract the number you got from your liabilities from your assets total and you get what is called — Net Worth.
That is in pure $$ terms what you are worth (not your real personal value…that is priceless) but from a purely material standpoint, this is the magic number.
It’s important for 2 reasons:
1. Let’s you understand your current financial situation. Is my net worth positive or negative? If I sold absolutely everything I own and paid out everything I owe would I be left with money or would I still owe some?
2. It gives you a reference point for measuring progress toward your goals. Are you moving in a positive direction in your net worth, or going backward?
The only way to really know is by looking at the numbers and doing this exercise. I would recommend doing it at least once per year, if not every 6 months or more depending on your situation and how stable it is.
A simple excel spreadsheet that you update the numbers will give you a clear picture of your situation at a glance. Or even better, reach us at Career Year Academy and we will provide you with complimentary templates that will make it simple for you to track your progress.
Keeping an eye on your net worth and seeing it going up is a great way to know if you are on the right track financially.
Finally, the last topic to look at is Cash Flow…. what is cash flow?
Simply it’s how much cash you have at the beginning or a said month or year or set period of time…vs how much you have at the end of that month or year or set period of time.
If you have more at the end of the month than at the beginning…you would be Cash Flow Positive.
If you have less at the end than at the beginning, you would be Cash Flow Negative.
In other words, it’s the difference between the amount of cash in (revenues) and cash out (expenses) every month.
So, what is the difference between Net Worth and Cash Flow?
Net Worth is the total value of your assets minus your liabilities…
Cash flow is how much ready cash you have every month, for example, over and above your living expenses.
So, for example, I may have a high net worth, but it’s tied up inside a company, or shares or a property that isn’t ready cash to spend.
On the other hand, my monthly expenses are high and I don’t have a lot of disposable income.
You would call this situation Asset Rich — Cash Flow Poor.
An old boss of mine was in this exact situation for a few reasons. He had built a successful company which was worth several millions of dollars…when he would sell it.
But until he did sell it, most of his income was reinvested inside the company and his actual take home spendable salary was much lower.
His lifestyle was also tied to a large home and condo which took most of his income to pay off the mortgages.
Now if he was to sell his company and properties, his Net Worth on paper was millions. Yet his monthly cash flow due to his situation and lifestyle was actually quite poor.
Sometimes we will also use the term, House Poor. It’s meant to define people who own and live in a house much larger and expensive than their current cash flow can sustain.
This means that most of their income goes to support their mortgage and maintain their house, leaving little to no money left over for anything else. Hence the term House Poor.
Regarding assets and liabilities, there are accounting terms and rules as to how they should be classified.
However, there are other people such as author Robert Kiyosaki from his famous book series Rich Dad Poor Dad and Cash Flow Quadrant, and many more who make the argument that an Asset is only an Asset if it is generating money for you.
Take a car for example, is it an asset or a liability?
It could be both…if your car is worth more if you sold it than the amount of money you currently owe on it, then from an accounting standpoint it would be considered an asset
If you owe more on the car than you could sell if for…again from a purely accounting standpoint it would be a liability.
New cars tend to lose on average 25% of their value the minute you drive it off the dealerships parking lot. You also still have to pay gas, repairs, insurance, license, perhaps parking. So it costs you money every month and lowers your cash flow. Therefore, your car is a cost…a Liability.
What about a house? Aren’t houses assets? Not according to Kiyosaki. See they usually go up in value, but as we’ve seen throughout a few recessions, that is not always the case.
The other thing to consider is upkeep, repairs, maintenance, taxes and the interest you pay on that house costs you money each and every month…so by definition, it becomes a liability.
Let me give you 2 examples to illustrate how you can turn a liability into an asset…and vice versa.
Going from 5 roommates to 1
When I was 20 years old and going to University, I purchased a house close to campus which had 4 bedrooms plus a 2-bedroom downstairs apartment.
My monthly expenses to pay the mortgage, taxes, and maintenance came up to around $1000 per month. My take home in revenues from renting out the extra rooms and apartment was $1450 per month.
So my home was providing me with a positive cash flow every month of $450, plus it also allowed me to be living rent-free and paying down my mortgage all at the same time.
So even if the house never would have gone up in resale value, it was still an asset in every sense.
A few years went by and I then sold that house and took the profits from the sale to put a down payment on the purchase of a new one in Ottawa so my future wife and I could move in together.
No roommates in this one ;)
But no rental income either!
Now I had to pay off the mortgage, taxes, and expenses every month and turned what was an income generating asset — my rental property — into a property that cost me money every month.
Or as Kiyosaki would call it…a liability.
From a Daytona to an Aerostar
The same year I purchased that rental property, I also started a painting and landscaping business.
I owned a cool 1988 Dodge Daytona car at the time but now I needed something more robust to help me run my business so I traded in the car for a 1988 Ford Aerostar. It was a beautiful two-tone color — brown and rust. My dad helped me take out the back seats so I could fill it with built-in storage for my gear and painting supplies. Metal roof rack for the ladders and logos on the side, a real head turner if you can get the picture.
Both vehicles had a cost to run them…but only the van had the ability, in this case, to help me make money. Only the van could be used as an asset and a business tax write-off as well. So double bonus.
So in this example, I took an asset — my car (or as Kiyosaki would say a liability since it cost me money every month to run and maintain, and turned it into an asset, a tool that helped generate income for my business.
An asset puts money in your pocket…a liability takes money out of your pocket.
To wrap this up, The best advice I can give you is the following:
1. Don’t accumulate liabilities early on in life. You will spend a great deal of time effort and money trying to get back to positive net worth if you do.
2. Work hard to get to a positive cash flow situation as early as you can. Even if that means cutting back on some small luxuries in the beginning. Then use that cash flow to purchase income generating assets.
3. Only once your assets themselves pay you more every month than your cost of living should you start to increase your lifestyle. A great read to understand this mindset is the Millionaire Next Door. Would you rather LOOK rich, or BE rich?
If you keep your cash flow negative, over time your liabilities will increase and you will lose the lifestyle.
If you keep your cash flow positive, over time your assets will increase and you will increase your lifestyle.
Like I said at the beginning, not the most exciting topics in the world…but trust me, if you can understand these complex yet simple to apply concepts…you will have many more options to live an exciting life in the future!