To put the importance of net worth in perspective and further clarify the term, we are going to provide an analogy of a Profit-and-Loss Statement (which shows your business revenue and expenses for a specific time) and a Balance Sheet of a business compared to the finances of an individual.

People earn money. Those earnings can come from working or from assets (investments). Earnings are the same to people as revenue is to a business. People spend their earnings on living expenses (i.e., rent, food, insurance, entertainment, etc.), interest on money owed, and taxes. The living expenses of a person compare to the operating expenses of a business.

The hope is that when a person’s living expenses are subtracted from their earnings, something will be left over. For a person, that might translate into savings; for a business that would be retained earnings (profits of the business that have not been paid out to the owners).

What happens to a person’s income when they are laid off from work? What happens to a person’s income when their dividends or interest rates are lowered? The result is that there is less money available to pay expenses and there is less money for savings.

At this point, a person usually starts to cut back on expenses. If, even after cutting back, a person doesn’t have enough income to meet expenses, debt increases. In business, it is a net operating loss when business deductions exceed business income for the fiscal year. That’s when the Balance Sheet is crucial and becomes the deciding factor between a person or a company’s financial life or death.

If that person’s Profit-and-Loss statement (P & L) isn’t working, what options are available to him or her? If that person has no Net Worth, other than making draconian cuts in expenditures and taking any work, there are no options available. When a person has Net Worth, there are two options available: Sell assets or borrow money.

If the decision is to sell assets, the financial document on which these assets reside is the Balance Sheet. If the decision is to borrow money, a lender looks for collateral from a potential borrower, and collateral resides on the Balance Sheet. The length of time that a person or company can survive financially depends on the size of their Net Worth.

The CEO of a Fortune 500 company was quoted saying, “Budgets are meaningless. It is impossible to predict income and expenses in today’s uncertainty.” Well, we disagree. Budgets aren’t meaningless. Every company needs a roadmap to follow. Granted, in today’s fiscal climate, it may be a work-in-progress road map, it is still better than working in a vacuum.

That aside, what was that CEO really saying? One interpretation might be that because of economic uncertainty, the CEO doesn’t have a handle on the company’s future earnings and has written off the company’s P & L for the next year. How long will these uncertain times continue? Because the times are uncertain, we can’t predict their length. Given that reality, how many P & L statements is that CEO going to write-off? More to the point, how many P & L statements can the company afford to write-off? The answer to that question is in the company’s Balance Sheet. The Balance Sheet will determine which options are available to buy time and how much time the company has.

To paraphrase a well-known Ben Franklin quote, “In this world nothing is certain but death and taxes.” NetGain would like to add, “Until the American business model changes, there will be economic recoveries.” Be there for it.

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