FOUNDATIONS OF FINANCIAL FREEDOM - Financial Literacy 101: Understanding Money Basics
By Robert Morgan, Founder of Living Beyond Line of Sight
Introduction
Ever feel like money's more of a mystery than it should be? You're not alone. Financial literacy isn't just for Wall Street experts—it's a fundamental skill that helps you achieve your life goals, big or small. From buying your first home to starting that dream business, understanding the basics of money management is the first step toward turning aspirations into reality.
Key Concepts
Income vs. Expenses
Let's start with the flow of your money. Income is all the cash flowing into your pockets—think salary, freelance gigs, or side hustles. Expenses are where your money flows out—like rent, groceries, Netflix subscriptions, and that daily latte habit.
Why does this matter? Because cash flow is king. Positive cash flow means you're earning more than you're spending, giving you room to save, invest, or splurge a little guilt-free. Negative cash flow? That's a sign it's time to reassess and tighten up the budget.
Assets vs. Liabilities
Next up, the building blocks of wealth:
Assets are things that put money into your pocket. This includes savings accounts, stocks, real estate, or even a profitable hobby.
Liabilities take money out of your pocket. Think loans, credit card debt, or that car payment that seems to never end.
Understanding the difference helps you make choices that grow your net worth. The goal? Accumulate assets and minimize liabilities.
Net Worth Calculation
So, how do you know where you stand financially? Calculate your net worth. It's like a snapshot of your financial health.
Here's the simple formula:
Net Worth = Total Assets – Total Liabilities
Add up the value of everything you own (assets) and subtract everything you owe (liabilities). The result is your net worth. It's okay if it's not where you want it to be right now—the important thing is that you're starting to pay attention.
How Can Something Be an Asset and a Liability?
You might notice that items like your house or car are both assets and liabilities. That’s because larger purchases take a while to pay off. The part you own is an asset, but the part you owe is still a liability because debt always creates risk.
Creating Your Own Balance Sheet
Use these examples as a template to craft your personal balance sheet:
List All Assets:
Cash and Savings: Checking and savings accounts.
Investments: Stocks, bonds, retirement accounts.
Property: Home equity, vehicles, valuable possessions.
List All Liabilities:
Loans: Student loans, mortgages, auto loans.
Credit Card Debt: Outstanding balances.
Other Debts: Personal loans, medical bills.
Calculate Net Worth:
Net Worth = Total Assets – Total Liabilities
Let's dive deeper into creating a personal balance sheet by looking at some real-life examples. We'll explore both positive and negative net worth scenarios to give you a clearer picture of how this works in practice.
Examples
Example 1: Positive Net Worth
Meet Alex, a 28-year-old graphic designer who's been working for a few years.
Assets:
Savings Account: $10,000
Retirement Account (401k/IRA): $15,000
Car: $8,000 (current market value)
Investments: $5,000
Total Assets:
$10,000 + $15,000 + $8,000 + $5,000 = $38,000
Liabilities:
Student Loans: $7,000
Credit Card Debt: $1,500
Total Liabilities:
$7,000 + $1,500 = $8,500
Net Worth Calculation:
Net Worth = Total Assets – Total Liabilities
Net Worth = $38,000 – $8,500 = $29,500
Alex's Net Worth: $29,500
Insight: Alex has a positive net worth, indicating healthy financial habits like saving and investing. The manageable liabilities mean they're on a solid path toward increasing wealth.
Example 2: Negative Net Worth
Meet Jamie, a 24-year-old recent college graduate starting their first job.
Assets:
Checking Account: $1,200
Used Car: $4,500
Personal Belongings (electronics, furniture): $2,000
Total Assets:
$1,200 + $4,500 + $2,000 = $7,700
Liabilities:
Student Loans: $30,000
Credit Card Debt: $3,000
Car Loan: $4,000
Total Liabilities:
$30,000 + $3,000 + $4,000 = $37,000
Net Worth Calculation:
Net Worth = Total Assets – Total Liabilities
Net Worth = $7,700 – $37,000 = -$29,300
Jamie's Net Worth: -$29,300
Insight: Jamie has a negative net worth, which is common for many starting out. Significant student loans and debts outweigh their current assets. The focus here should be on increasing income, reducing expenses, and prioritizing debt repayment.
Example 3: Positive Net Worth with Property
Meet Sam, a 35-year-old professional who owns a home.
Assets:
Home Value: $250,000
Retirement Accounts: $40,000
Savings: $20,000
Car: $12,000
Investments: $10,000
Total Assets:
$250,000 + $40,000 + $20,000 + $12,000 + $10,000 = $332,000
Liabilities:
Remaining Mortgage Balance: $200,000
Auto Loan: $5,000
Credit Card Debt: $2,000
Total Liabilities:
$200,000 + $5,000 + $2,000 = $207,000
Net Worth Calculation:
Net Worth = Total Assets – Total Liabilities
Net Worth = $332,000 – $207,000 = $125,000
Sam's Net Worth: $125,000
Insight: Even though Sam has substantial assets and is building equity, the large mortgage results in a reduced positive net worth. Over time, as the mortgage is paid down and property value appreciates, Sam's net worth will likely continue to improve.
Understanding the Examples
These examples highlight different financial scenarios:
Alex demonstrates how manageable debt and consistent saving lead to positive net worth.
Jamie shows that starting out with student loans and debts is common, but also emphasizes the importance of addressing liabilities early.
Sam illustrates that owning assets like property can still result in a significant positive or negative net worth depending on liabilities amounts, but also points to the potential for growth over time.
Actionable Steps
Create a Personal Balance Sheet
Ready to take action? Start by creating your own balance sheet:
List Your Assets: Savings accounts, investments, property, valuable belongings.
List Your Liabilities: Mortgages, student loans, credit card debt, any other owed amounts.
Calculate Your Net Worth: Use the formula Net Worth = Total Assets – Total Liabilities
This exercise gives you a clear picture of your finances and highlights areas for improvement.
Regularly Track and Review Financial Statements
Knowledge is power, but consistency is key. Set a monthly date with yourself to review:
Income and Expenses: Use apps or spreadsheets to track where your money goes.
Net Worth Progress: Update your balance sheet to see how you're improving over time.
Regular reviews help you stay on top of your goals and adjust as needed.
Conclusion
Taking control of your finances starts with understanding these fundamental concepts. It's not just about numbers—it's about empowering yourself to make informed decisions that align with your life goals. By grasping the basics of income vs. expenses, assets vs. liabilities, and knowing how to calculate your net worth, you're laying the groundwork for a solid financial future.
Remember, every expert was once a beginner. Embrace this journey toward financial freedom—your future self will thank you.
Up Next Time
Feeling more confident about creating your personal balance sheet? Fantastic! In the next installment of our "Foundations of Financial Freedom" series, we'll delve into "Budgeting Made Simple: Crafting a Plan That Works for You." Get ready to transform your financial habits and take control of your money like never before.
Stay tuned, and remember—every journey begins with a single step. You've got this!
To learn more reach out at www.living-blos.com or email directly at Robert@living-blos.com .