What is net worth and why is it important in personal finance planning?

An understanding of one's net worth helps an individual make better financial decisions

Viral BhattUpdated: Sunday, July 03, 2022, 02:58 PM IST
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An individual’s net worth is nothing but the difference between the assets and liabilities occurring in his/her finances. If the assets owned by an individual are greater than the liabilities then s/he will have a positive net worth and vice versa. Calculation of net worth is easier than it sounds. 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 figure out how to bring it to optimum condition and or how to maintain it. This is why calculating net worth is important.

Let us see how net worth can be a significant aspect of personal finance.

Practically states when you can retire

The question where all personal finance answers are routed to, yet nobody knows it precisely. Although one way to find it in an absolute sense is by weighing in the net worth question. For example, there is a couple who earns Rs 20 LPA and has assets worth Rs 1.2 crore. Now, the same couple also has Rs 50 Lakh in debt as on the date of calculation. The net worth of the couple here will come at Rs 70 Lakh (1.2 cr – 50 lakhs), which is positive but does it mean the couple can retire? The debt of Rs 50 Lakh is being repaid by considerable EMIs, which are being catered to by the yearly income of Rs 20 LPA. Therefore, in case the couple decides to retire they cannot afford the EMIs anymore so they will need to cash in all the assets and pay the debt. After this, they will be left with Rs 70 Lakh without any assets, which may or may not be deemed enough to retire.

Re-align your goals

Negative net worth needs not rocket science to figure out that your financial health needs saline. It's like using mobile GPS — once you know where you stand and have a brief idea of where you want to be, finding the road can be easy. Moreover, even if your net worth is positive, you may have fallen off track in achieving your destination. In such cases, net worth calculation helps you change your savings, investment, and spending habits to re-align with your financial goals.

A look at assets from a different perspective

Debt is something you owe, while assets are something you own. But the definition of assets and liabilities in net worth goes beyond this. Debt can be categorised as long-term or short term but in the end, both of them need to be paid. The important categorisation is assets, which can either be current or non-current assets. The current assets can be converted into cash in minimum time, which is opposite to non-current assets. For better understanding, here's an example of a person holding a non-current asset worth one crore rupee, which prima facie seems good enough for retirement, without debt. However, if such an asset is your home, which may not fetch income today or in future, such an asset may not be entirely helpful nor can your retirement be dependent on such asset. 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 to longer credit period

Heard the name called CIBIL score? Net worth is not too far from it and in fact, may give more specific information than CIBIL. Net worth in simple terms states the worth of an individual. Thus, positive net worth can fetch you better loan deals from banks. But such positive net worth shall be after taking into consideration the prospective loan. The reason being the difference between assets and liabilities may not be significant enough, which might result in a negative net worth after borrowing. Banks and lenders have a closer look at your net worth and when in need of funds, a negative net worth may go against 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 firm)

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