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Thursday, October 29, 2020

Your Personal Balance Sheet

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For companies a financial balance sheet (i.e. the statement of the financial position at a certain date) is common practice and for the majority of companies even mandatory to create one as part of their annual reporting.
In such a balance the assets are put against the liabilities, with the sum of the assets always equal to the sum of the liabilities and equity.

While this is such a common tool for companies, for individuals it’s almost funny to speak about a personal financial balance. Nonetheless such a balance can give you (just as for a company’s balance sheet) very interesting insights in your personal life
and more specifically in your personal finances.

For individuals instead of a real balance sheet, we usually work with a holistic wealth overview, which calculates your total wealth, by subtracting the liabilities from your assets. This means it doesn’t use the same categorizations and visualizations as
in a corporate balance sheet, which is a pity as corporate balance sheets have a widely accepted standardization and have evolved through years of practical experience.

If we consider a purely financial personal balance, which is setup in the same way as a corporate balance sheet, this would have

At the left-side, the asset side

  • Current assets (i.e. cash and assets expected to turn into cash within one year), containing

    • Cash and cash equivalents, such as cash in your wallet, current accounts, some saving accounts, pre-paid vouchers (such as meal, eco or gift vouchers)…​

    • Accounts receivable: normally this contains all pending invoices, which have not been paid yet. For a personal balance sheet (apart from the independent professionals) we typically don’t work with invoices, but we could consider all accrued income in this
      category, such as accrued salary (including accrual of holiday pay or 13th month), accrued interests, accrued rent, accrued tax repayments (e.g. if you know you get taxes reimbursed every year X euros from the government)…​ These types of accruals are typically
      not showed, but can give interesting insights in your financial situation.

    • Short-term investments, i.e. investments with a short duration, which you expect to liquidate within 1 year (e.g. short-term term deposits).

    • Inventories: as a lot of regular expenses are bursty (e.g. going to the supermarket is a weekly burst, going to petrol station is a 2-weekly burst…​). To reduce this bursty effect on your balance sheet, it can be interesting to valorize your groceries, fuel
      and other regularly consumed products as inventory, which are written off over the time of the recurrence of the spending.

  • Non-current assets (i.e. assets which are not expected to be liquidated within 1 year):

    • Long-term financial investments, such as some saving accounts, long-term term deposits, securities accounts, life-insurances, pension saving plans, option or equity plans, crypto-currencies, private equity, crowd funding…​

    • Non-financial assets, such as

      • Real estate (own house, but also 2nd residence or rental properties)

      • Car(s), boat(s) or even plane(s)

      • Household (e.g. furniture)

      • Art and collections (such as stamps, coins, wine…​)

At the right-side, the liabilities and equity side

  • Current liabilities (debt due in 1 year), containing:

    • Short-term credits, like consumer credits, credit card debts, bridge loans, overdrafts…​

    • Accounts payable: normally all invoices which still need to be paid are included in this category, e.g. utilities bills. Just as for the asset side, it might also be interesting to work with accrued expenses, such as accrued utility and telecom expenses
      (such as water, electricity, gas, telecom…​), accrued rent payments, accrued tax payments, accrued leasing payments…​

    • Tax payable: while for employees taxes are usually immediately deducted from the salary, this section can be interesting for professionals, which need to pay taxes based on their annual income.

  • Non-current liabilities (i.e. liabilities due in more than 1 year):

    • Long-term loans, such as mortgages or long-term consumer credits, but potentially also family loans (which are expected to be paid back).

    • Equity: equity is usually split up in “Capital”, “Retained earnings” and “Current earnings”. For an individual you could say that “Capital” is all money you received from family (i.e. donation and inheritances), while the earnings is money you gained yourself.
      To make the difference between “Retained earnings” and “Current earnings”, a fixed date per year could be set to calculate your annual earnings.
      The equity part actually gives you a view on your actual wealth, but the split-up in the 3 sub-categories allows to get more info about the origin.

Note: all assets and liabilities on the balance sheet should be valuated as much as possible at the current market value (and not book value).

While the above view is a purely financial view, we could also consider less financial elements, like

  • Intangible valuables or intellectual property (patents, copyrights, diplomas, trademarks…​). Usually obtaining those assets requires an investment both in time and money, but often will result in increased future revenues. The difference
    between the investment cost and expected revenues could be put under “Goodwill”, allowing to quantify upfront the added-value of these intangible values. Of course, this “Goodwill” should be amortized over time when expected revenues become a reality (or don’t
    get realized).

  • Off-balance positions such as unused credit lines (linked to account overdrafts or credit cards), insurances (like car, home or medical insurances), loyalty programs/cards (could potentially also be put under current assets), company car
    (not your property, but resulting in a significant reduction of future expenses)…​

Once the balance has been created in a digital way, it becomes interesting to have digital tooling (such as PFM tools) to allow quick (automated) and easy analysis on the balance to gain new insights (e.g. where improvements can be made), e.g.

  • Apply filters to include or exclude certain elements, e.g.

    • Include accruals of assets/liabilities or not

    • Include inventory or not

    • Include shared assets/liabilities with partner (at 100% or 50%) or not

    • Only financial positions or also non-financial positions

    • Include gifts/inheritances from family or not

  • Allow easy visualization and comparison of your personal balance sheet over time (to easily see how certain categories evolve over time)

  • Calculation of financial ratios, which give a quick idea of your solvency, liquidity and capital structure, e.g.

    • Working capital (Current assets – Current liabilities) giving an indication of the liquidity buffer you have (idem for Current or Quick ratio)

    • Debt ratio (Total liabilities divided by total assets) giving an indication of your exposure to debt

  • Execute simulations, such a stress analyses, to see the impact of certain scenarios on your personal balance. Financial planning tools often provide features for this.

With PFM and Financial planning tools becoming more democratized, more powerful, but especially more automated (not requiring yourself or a financial advisor to manually input and maintain all the balance figures), a personal balance sheet will become more
common. It will be interesting to see if banks can provide interesting services to easily create, maintain and visualize such balances and automatically derive valuable insights and actionable proposals out of them.

 

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