Let’s talk net worth

Today is the final day for filing 2012 taxes here in the U.S.  And I’m sure that anyone with any desire to do so can find any number of articles about writing and taxes.

(Hint: You should think about tracking your expenses and, if your income from writing is sufficiently high, you should be making estimated tax payments throughout the year.  If it’s not all that high, I’d personally recommend changing your withholding at your day job to account for whatever taxes you’ll owe on your writing income.)

So, since that’s pretty easy to find, I thought I’d instead talk about one of the things I look at when I budget.  Now, remember, I am not yet published.  But.  For the last three years I’ve been an independent contractor, so I’m basically my own poorly managed business.

(I say poorly managed because my focus has not exactly been on increasing revenues and diversifying my client base.  In fact, from a business perspective, I suck at running my own business.  From a living a life I enjoy perspective, though, I am rockin’ it.)

Anyway.  I love spreadsheets.  (I could not live without Excel.  Although I would probably create little handwritten ledgers if I didn’t have it around.)  And I manage my finances using a very large spreadsheet that has many tabs, including one with my monthly expenses, one that lists my assets/liabilities, one that tracks my income, one that estimates my annual taxes based on my income, and one that lists various scenarios and how much those would cost me.  (You know, like “What would I need to earn this year if I decide to go spend six months in Belize?”)

I could devote thousands of words to discussing how I approach all of this, but the one I want to talk about today is the net worth estimate.

For most of my 20’s I didn’t really like to think about my net worth, because it was a negative number.  A very large negative number.  Which meant that if I had died back then and someone had sold off everything I owned and tried to pay off everything I owed there wouldn’t have been enough money to pay for it.

But it’s essential to think about this number.  I use it as a proxy for cash flow, which is what you need to be able to manage if you’re going to be juggling your finances in any way.  (And who hasn’t had to do that at one point or another?)

So, net worth as I define it = Assets – Liabilities.  What do you own?  What do you owe?  What is the difference between the two?

Now, being the type who likes to make things complicated, I don’t stop there.  I also calculate liquid net worth, which is what those assets are really worth to me today not just what they’re worth on paper.  So, for example, my retirement accounts aren’t really worth their balances.  By the time I pay the IRS penalties and taxes on the money from those accounts, they’ll be worth about half what my statements say they’re worth.

(I should probably take a moment here to mention that I like to be conservative in my estimates.  I saw someone suggest today that people set aside 20% of their income towards estimated taxes.  Me, I set aside 45%.  Yeah, that’s been too much.  But I’d rather get to the end of the year and find out that I overpaid and now have some extra money in the bank than get to the end of the year and find out I underpaid and that I now owe more money and penalties.  And don’t forget you need to make estimated state tax payments as well as federal…)

(I also used to round all expenses in my checkbook up to the nearest $5 and all deposits down to the nearest $5.  Drives accounting types crazy, but it meant that in college when I lived very close to the wire that I could rebalance my checking account every six weeks or so and find an extra $50, which was enough for a couple weeks’ groceries.  That, of course, died with online account access.)

OK.  Back to the discussion at hand.  Net worth.  So, I not only do basic net worth (assets-liabilities), but also liquid net worth (liquidation value of assets – liabilities).  The other thing I do, and probably the point of this article (only took 700 words to get here), is that I look at my short-term liquid net worth and my long-term liquid net worth.

This is key.  No one wants to have a negative net worth.  It’s not a good thing.  But it’s life for many people these days. What you should absolutely try to avoid is having a negative short-term liquid net worth.

To me, short-term liquid net worth is what I will have available to me in the next month minus what I will owe in the next month.  If what I will have is less than what I will owe then I’m going to have late payments, which means penalties and fees and it starts a death spiral you want to avoid.  (If you didn’t have the money to pay a bill, you certainly won’t have the money to pay that bill and its associated penalties.)

(And this is probably a controversial recommendation, but it worked for me at the time.  At some point in my 20’s, I deliberately took money from a line of credit and put one month’s expenses in the bank.  So, I owed more than I had before, but I also knew that going into each month I had the money in the bank on the first of the month to cover my expenses for that month.)

Let’s talk this calculation through.  How do you calculate your short-term liquid net worth?

First: What are your short-term liquid assets?  For me that’s my bank checking and savings accounts and any business receivable I have.  For someone with a day job that might include your expected pay for the month.

(Be conservative here.  Don’t count on income that isn’t reliable.  If you do contract work and you don’t know that your client will pay on time, don’t include it in your calculation.  If you sell a story and you’re not sure when you’ll receive payment, don’t include it.  And don’t include anything that will incur a penalty like a 3-month CD.)

Second: What are your short-term liabilities?  Same idea as above.  What are you going to owe money on in the next month?  For me I put a month’s expenses, my credit card balance, and my estimated tax liability here.

(If you can’t afford to pay off your credit card each month then don’t include your credit card balance.  (Whatever you pay on it monthly should be in the month’s expenses number.)  If you’re not self-employed or don’t have writing income, then no tax liability.)

So, short-term liquid net worth = Assets I could access in the next month – Expenses I have to cover in the next month.

(Obviously this isn’t going to help you if those assets are available on the 30th of the month and all the expenses come due on the 1st, so use some common sense when you match these things up to one another.)

If you can keep your short-term liquid net worth a positive number, then you can at least meet your current obligations.  And, as long as that number stays positive, then you should be able to maintain good credit and avoid an ulcer from fielding bill collector calls.

Ideally, your total net worth is a positive number and your long-term net worth is also a positive number (For long-term net worth I put my retirement accounts and property in the assets and my student loans and mortgage in the liabilities.)  But having a negative long-term net worth number isn’t going to make your current life miserable.

(Not to mention that if you financed college with student loans or bought a home that was a bit of a stretch it’s pretty much a guarantee that your long-term net worth number will be negative at least when you’re starting out.)

As a final note on this.  If you have variable income then you really want that short-term liquid net worth number to not only be positive, but to also be high enough to cover a couple months’ expenses.  That gives you room to maneuver in.  If you’re not bringing in income this month, then you still have two months to figure out how to bump up those assets.  Pick up some side work, donate plasma, sell your grandma’s china.  You know, whatever you need to do…

Well, hope that made a bit of sense.  Sometimes what works in my mind doesn’t really work outside of my mind.




About M. H. Lee

M.H. Lee is a speculative fiction writer currently residing in Colorado whose stories are sometimes dark, sometimes funny, sometimes darkly funny, but hopefully always thought-provoking and entertaining.
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