Wednesday, March 26, 2008

Explanation of Credit Card Balances in Net Worth

Each month, I post my net worth, which includes various lines for assets such as bank accounts and investments, and also lines for liabilities such as credit card balances. Quite often, I get a question from a reader asking "why do you carry a balance on credit cards when you have all that cash?"

I always respond in the comments, but I thought it was worth explaining in a separate post.

When you're calculating your net worth, it's important to look at where you stand at the current moment, in terms of what you have, and what you owe. If you are dead broke, and somehow manage to borrow a million dollars that you don't have to pay back for ten years, is your net worth be $1 million? No-- you're still be broke. You have the million dollars-- that is an asset. But you owe $1 million-- that is a liability. They cancel each other out, so your net worth is zero. Even if it's not due back to the lender for 10 years, you owe that money, it's not yours free and clear. (Someone who knows more than I do about more complicated methods of accounting might point out some nuances here having to do with interest, etc. but the basic point still holds.)

As I've pointed out in my Rule #1, I always pay my credit cards in full every month. The bill is usually due sometime mid-month. I am charging things constantly throughout the month. Although I never "carry a balance," as in carrying it month to month, the balance on my card is never zero. Even if I took a break in using it, and the balance was zero right after I paid my bill, it might not still be zero by the end of the month when I calculate my net worth. Any time there is a balance on my credit card, that is money that I owe to the credit card company at the moment when I am calculating my net worth, so it has to be shown as a liability. I am using my credit card to get an interest-free loan for a month, but it's still a loan. The money I'll use to pay it back may still be in the bank, but I have to account for it in calculating my net worth.

So I hope everyone is remembering to include whatever they owe on credit cards when calculating their net worth-- even if it's only $50, even if you're going to pay it off tomorrow, it's still a liability today.

14 comments:

Mr. Stupid said...

This is exactly the way I calculate my new worth. Frankly, I am surprised you have to answer that question.

calgirlfinance said...

Madame X,

I agree that you should include your current credit card balances in your networth statement. I also include them in my personal calculations since they can have a significant impact on what my networth looks like for that month. I probably charge about 90% of my expenses (excluding rent) onto my credit card so I often have a $3K balance, which gets paid off every month.

Anonymous said...

M, do you include salary accrued, but not paid? This may not apply if you get paid monthly and measure net worth monthly. I get paid biweekly, so occasionally it is material enough to include. How about accrued vacation? Companies book it as a liability. I try to keep my balance in the mid-20 days, knowing that when I leave I'll get it paid out.

Madame X said...

Anon 11.57-- no, I don't add in accrued salary or vacation. I get paid twice a month, so when I calculate my net worth as of the last day of the month, it's right up to date. I also often forget to count business expense reimbursements that I haven't received, and I ignore medical FSA account balance/pending reimbursements. There's a point at which things can get a little too complicated, but the credit card thing definitely matters, as my monthly spending on it can be around $2,000.

Anonymous said...

This makes sense to me - you include your credit card balance the same way you'd include a check you've written that hasn't cleared when balancing your checkbook (does anyone still do that anymore in the age of online banking?)

I'm with mr. stupid - I'm also surprised you had to answer the question.

DogAteMyFinances said...

I'm not sure why this astounded so many people. I do the exact same, except I count the "check in the mail" or billpay that has already been deleted but not applied yet.

Kirsten said...

I see your point and it certainly makes sense to see a credit card balance as a liability. However, could you not also see it simply as an unpaid bill?

Let's imagine you're calculating your net worth at the end of every month (like I do) and you just received an electricity bill due by the middle of the next month (i.e. in 2 weeks time). Do you deduct that from your net worth? If so, I'll be quiet. If not, why do you treat your credit card differently? It's just a bill that needs to get paid on time, isn't it?

I probably don't have to mention that I don't deduct my credit card from my monthly net worth statement and I find it doesn't really make a difference since the amount every month is similar anyway. When I prepare my net worth at the end of the month, I take a snapshot of what I have - and there is certainly money in my savings account that is earmarked for the credit card but at this point in time, it is still my money, earning interest for me.

Anonymous said...

It would also make sense to determine, at your date of reporting, exactly where you stand wrt: property taxes, mortgage interest, PayPal account, commuter rail pass, accrued bank interest, and even utilities like cable and water.

I even count my on-hand change so I have the confidence of 2-decimal accuracy in my net worth reporting.

When 3-decimal accuracy becomes possible, look for me to be an early adopter.

And, of course, I share GE's vision of 6-sigma accuracy as a 2010 goal. Who wouldn't?

Anonymous said...

I understand why you would want the credit card to be calculated into your networth but what about your mortgage. I bought a condo 2 years ago which made my net worth go red by $170k. Now I'm thinking of opening a business and the bank wants to know my net worth. I thought my house was an asset or at least partially considering I am paying into the principal. Can anyone explain this or is the concept the same as the credit cards..as long as I owe it counts against my net worth. Thanks!

~Sonri

Madame X said...

Sonri-- yes, you should count the value of your house as an asset, and subtract the outstanding balance on your mortgage as a liability-- the difference between the two is your eguity in your home. I include this in my net worth, but I tend to do the math behind the scenes, and just show the resulting net home equity.

Madame X said...

anon 12:09, you mock, but I seriously do include my paypal balance, and all change on hand!

josh said...

I wish I had your determination madame x - I have to say that budgeting out every penny, while being the smart thing to do, would drive me nuts.

My current budget includes all of my fixed bills, and allocates $150 a week for gas/food/fun. That's about as in-depth as I've gotten.

Anthoney Grigsby said...

I agree. I include my credit card into my net worth statement. But I have a slightly different situation. I'm building a practice dead credit score, so I had to settle with a secured credit card, meaning I had to establish my own credit with my own money. So I have to maintain an available credit which in turn results in a asset for me and not a liability.

Experts on Credit said...

I include my credit cards also. Helps offer a better picture of where you stand financially.

Experts on Credit