Net worth

Ask most people how they are doing financially and they will tell you what they earn. That is the wrong number.

Income is a flow — it arrives and it leaves. Net worth is a stock: what would be left if, today, you sold everything you own and paid off everything you owe. It is the score at the end of every year of earning and spending, and it is the only figure that shows whether the years are adding up to anything.

The workbook puts it in six words: your net worth is simply assets you own minus liabilities you owe. Assets are items you own that have economic value. Liabilities are what you owe to others or have borrowed from them.

List both sides honestly and subtract. Two disciplines decide whether the answer means anything.

Value assets at what they would fetch, not what you paid. A car bought for Rs 6,00,000 four years ago is worth what a buyer will pay today. A house is worth today's market price, not the purchase deed.

Count every liability, including the ones you do not think of as debt — the outstanding principal on the home loan, the car loan, the credit-card balance you are rolling, the personal loan taken for a wedding.

What the number is for, in the workbook's words, is that "your net worth indicates your capacity to achieve your financial goals" — buying a home, paying for university education, future medical expenses, repayment of loan. It is the first of the five steps of the financial planning process: determine your current financial situation.

Track it once a year on the same date. The level tells you where you are; the direction tells you whether the plan is working.

Net worth = Total assets − Total liabilities

The workbook's own household, laid out:

Net worth = 55,25,000 − 20,10,000 = Rs 35,15,000

Now watch it move over one year. The family repays Rs 1,80,000 of home-loan principal (their EMIs total more, but the rest is interest, which is an expense and not a reduction in what they owe). They add Rs 1,20,000 to savings and investments. The car depreciates by Rs 10,000, and the house is unchanged.

Assets      55,25,000 + 1,20,000 − 10,000 = 56,35,000
Liabilities 20,10,000 − 1,80,000          = 18,30,000
Net worth                                 = Rs 38,05,000

Net worth up Rs 2,90,000 in a year — and notice that Rs 1,80,000 of that came from paying down a loan, not from investing. Debt repayment builds net worth exactly as reliably as a SIP does.

Chapter 3 (Financial Planning) opens with net worth under "Determine Your Current Financial Situation" and prints the assets-and-liabilities table above; Chapter 2 defines assets, liabilities and debt separately. The exam asks for the arithmetic — you will be handed a list of items and asked for the net worth — and asks you to classify an item as an asset or a liability. A fixed deposit is an asset; a loan taken from a bank is a liability.

• Net worth is not income and not savings. Savings are the surplus of income over expenditure in a period; net worth is the accumulated position at a point in time.
• A house bought on a loan appears on both sides — the property as an asset at market value, the outstanding loan as a liability. Counting only one side is the commonest error in the question.
• Only the principal repaid reduces a liability. The interest portion of an EMI is an expense; it never touches net worth through the liability side.
• Net worth can be negative, and often is early in a working life when an education or home loan is fresh. That is a stage, not a verdict.
• Do not confuse it with a company's net worth in the adviser papers, which is shareholders' funds on a balance sheet.
• A large net worth held entirely in property is not the same as a liquid one — that is the separate question liquidity answers.