Keep track of your total net worth


Business owners and professional firms know that they cannot effectively manage their business without understanding its financial situation. In the same way, when it comes to developing a comprehensive wealth plan, they also need a framework to assess their overall financial situation.

A “life report”[1] provides a comprehensive view of the owner’s assets, liabilities and net worth. Although similar to the more traditional balance sheet used to monitor their business, the life balance sheet includes both real and implied assets and liabilities.

The left side of the sheet lists the owner’s assets and includes traditional financial assets (cash, stocks, bonds, alternative assets, etc.) and other tangible assets (real estate, precious metals, art collections, etc.) . It also includes implied but expected assets.

Implicit assets are illiquid assets that are often non-marketable but have value. In a previous article, this was called “human capital”. Although often overlooked, human capital represents the present value of the owner’s expected income.

The passives, on the right side of the sheet, should be considered in the same way. Mortgages, business loans and other debt secured by property are explicit liabilities. Additionally, business and practice owners should include their succession goals as an implied liability and career professionals and non-business owners will include their estimated retirement costs.

For example, if you want to maintain a certain standard of living after you leave your job or retire, you create an implicit liability that must be funded by the assets on the left side of the life balance sheet. Aspirations to buy a vacation home, start another business, or fulfill a charitable commitment also represent implicit liabilities.

Think of a balance sheet with assets listed on the left side and liabilities on the right. The combined assets include a home, pension plans and the family business. Taken together, they are worth $2,000,000. To this we will add $800,000, the amount of money the owner expects to earn as income from the business. This increases the value of the total asset to $2,800,000/

Under Liabilities, we will list three common assets including a mortgage, tuition, and estimated retirement costs. These total $1,800,000. This leaves $1,000,000 as discretionary wealth; an amount that the person can use as they wish, but which will have a significant impact on their net worth, retirement, and even inheritance.

Using the life balance sheet helps owners, professionals and others assign a value (present value) to their implicit assets (their projected income) as well as their implicit liabilities (retirement and other costs). This information should encourage owners to review all of their tangible and real assets – including the value of their business – to ensure that they are on track to achieve their long-term goals.

[1] Wilcox, Jarrod, Jeffrey E. Horvitz and Dan diBartolomeo, 2006. Investment management for taxable private investorsCharlottetsville, VA: CFA Institute Research Foundation.

Source by Paul Brown

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