Assets and liabilities are directly connected to net worth through a fundamental financial relationship: Net worth is calculated by subtracting total liabilities from total assets.
- Assets are everything you own that has value, such as cash, investments, property, vehicles, and valuables. They represent economic resources expected to provide future benefits
- Liabilities are what you owe to others, including debts like mortgages, loans, credit card balances, unpaid bills, and other financial obligations
The formula is:
Net Worth=Assets−Liabilities\text{Net Worth}=\text{Assets}-\text{Liabilities}Net Worth=Assets−Liabilities
This means your net worth is the amount of money you would have left if you sold all your assets and paid off all your debts
. For example, if you own a house worth $250,000 and have $100,000 mortgage debt, the net worth contribution from the house is $150,000 (value minus debt)
. In accounting terms, this relationship is expressed as:
Assets=Liabilities+Net Worth\text{Assets}=\text{Liabilities}+\text{Net Worth}Assets=Liabilities+Net Worth
which shows that assets are financed by either liabilities (debts) or owner's equity (net worth)
. In summary:
- Assets increase your net worth.
- Liabilities decrease your net worth.
- Managing both-growing assets and reducing liabilities-improves your net worth and overall financial health
This connection is crucial for individuals and businesses to understand their financial position at any point in time
