Statement of financial position, Model 3, LO 3.1.1

Adam11733681
Adam11733681 Posts: 1

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edited November 3 in Financial Planners Professional Community

assets=liabilities + net worth, I’m a bit confused by this. Is this formula assuming that the credit card debt (liabilities) is a personal property (asset) on the other end. What if the debt was used to pay for a vacation, would this formula still apply? Does this formula only work if the liability is funding an asset? Pretty confused by this formula. Any help is appreciated.

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  • DavidMannaioni_CFFP
    DavidMannaioni_CFFP CFFP Faculty & Instructors Posts: 60 image

    This is one of those areas where it's easy to overthink. Like any basic math formula, this could be rewritten as net worth = assets - liabilities and achieve the same result. When a person uses debt (a liability) to buy an asset (like furniture on a credit card), there is no initial change to the person's net worth if they add $5,000 debt to acquire a $5,000 asset, their net worth doesn't change. But, if debt is used to buy a vacation, there is no offsetting asset to show for it and so one's net worth would decline.

    In practice, when gathering data from a client in order to understand their financial situation, you total up the value of all of their assets and then subtract all of their debt balances. The result is net worth. This is important information to have along with a cash flow statement as it can indicate if people are living within their means. Something all financial planners need to know.

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