Common Mistakes Entrepreneurs Make When Calculating Their Net Worth

July 5, 2016

9:45 am

Every entrepreneur dreams of financial independence. That independence entails more than just security, as it can allow for a healthy work/life balance, charitable endeavors, and more. The trouble is that managing personal finances, especially as an entrepreneur, can be challenging.

As surprising as it may sound, the most creative and inspiring people in business have trouble managing their personal finances. Why is that? It usually begins with staking personal finances to the success of a startup venture, as most entrepreneurs will stake a significant amount of their assets on their business, with the hope of seeing a significant return down the line.

While that investment is worth something on paper, it’s not the same as having money in a bank account – which makes it hard for someone in that position to calculate their true net worth. Doing so requires a shift in perspective as entrepreneurs are used to assessing the value of something by its potential for success.

While it’s good to expect great things from a business, it’s not wise to stake financial freedom on the chance that one’s company will get bought out or that the business will see continued success. For that reason, entrepreneurs should focus on the current value and earning power of their assets, and not their potential value.

Paul Adams, CEO and founder of Sound Financial Group, says that this situation is really more common than we might think. As a founder and entrepreneur himself, he understands the challenges that come with assessing net worth. His Washington-based firm manages millions in assets for business leaders, some of whom have learned this lesson the hard way.

According to Adams, entrepreneurs have some common misconceptions about their assets:

“It is not uncommon for entrepreneurs, or anyone for that matter, to look at physical holdings as assets when they might in fact be liabilities. For example, if you love your home and plan on staying in it, you shouldn’t consider it as an asset. The same goes for vehicles, collections, anything that holds value but that you are not willing to part with. As a rule of thumb, something should only be defined as an asset if it can be used to make money today, or in the future, without detracting from the lifestyle one wants to have.”

He also points out some of the mistakes entrepreneurs make when calculating their real net worth, and the banking world might be to blame:

“Most of the times, entrepreneurs include too many factors into their calculations. I often find it is more helpful to start with what they should not count first, to help them get on track. For example, banks are all too willing to let people include the aforementioned items as assets. The reason is they benefit as the lender, since these items can be leveraged as collateral for loans. While it is tempting for entrepreneurs to do the same when they are making their calculations, they should remember that the goal is to assess their actual worth for retirement, so they should stick to actual assets.”

As said before, the value of an entrepreneur’s business should definitely not be considered in those calculations, because that value is very volatile – something that Adams clearly agrees with:

“It may not be easy to accept, but a company is only worth what a potential buyer is willing to pay for it. Since that is a number that is bound to fluctuate with time and business performance, it is better not to include it as a calculation when assessing a net worth.”

Saving is a vital part of securing a healthy net worth over one’s lifetime. Many entrepreneurs are shocked at learning that their net worth is less than they had calculated or imagined, so the best way to prevent this is by being strategic and making investments that match your long term financial goals. If an entrepreneur has an accurate picture of the current balance sheet, then goal-setting and making plans for the future will be rather easier.

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25 y/o, born and living in Portugal. Majored in Biology, but tech and computers were always a passion. Wrote for sites like Windows.Appstorm and MakeTechEasier.

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