This month we have introduced the Net Worth Chart to show your Assets, Liabilities and Net Worth (or Equity) all in one place, so what does that mean in practice? Accounting can seem strange to non-accountants but this chart will give you insights into your business and alert you to potential problems in the future. Giving clarity and an accurate visual of where your business is heading.
What does the chart show?
The bars show your total assets and total liabilities and the line shows your Net Worth (or equity). The chart is best used by starting from the beginning of the financial year and showing actuals up to the Report Month. This will allow you to see the trend of what has actually changed this year and then what is expected to change in the next few months.
What are Assets?
Essentially they’re the things you own. Some of them are simple and obvious like the cash you have in the bank or the motor vehicles or equipment you’ve purchased. Debtors (customers who owe you money) are included too as they can be converted to cash – or we expect they will. Then there are the ‘intangible’ assets such as the goodwill you buy when you purchase another business.
All of these assets are valued in your accounts at the price you paid for them (less depreciation for your fixed assets) so don’t make the mistake of thinking that’s what you would sell them for. In some ways that would be a more useful number but it’s also a much more difficult one to work out – the cost price is clear, consistent and easy to work out.
What are Liabilities?
These are the things you owe to other people: Credit cards, loans, Trade Creditors (what you owe your suppliers) and similar accounts. It will include your outstanding GST and payroll obligations. In general liabilities are fairly obviously equivalent to their nominal cash value and if you were to wind up the organisation today, that’s what would need to be paid out.
So what is Net Worth?
Let’s start with what it’s not: it’s not the price you would get if you sold your business today. It’s calculated as your total assets less your total liabilities and starts with the issues of valuation of assets we discussed above. However, the value of your business is (hopefully) more than simple the difference between what you own and what you owe – it’s some (hopefully) higher figure based on your potential to earn income in the future.
The Net Worth figure can, however, serve as an approximation for the health of your business. What you want to see is an upward trend. Ideally your assets are greater than your liabilities (though that will depend on what stage your business is at) and over time you want to see that Net Worth line increase. If it’s trending downwards, it should ring alarm bells as you’re taking more out of the business than you’re bringing in. If the future projection is consistent with the past actuals and trending upwards, you’re heading in the right direction.
Use the Net Worth chart like you would use a canary in the coal mine. It will give you early warning of potential issues with your business model and give you time to seek advice before it’s too late to do anything about it.