When you’re an average Joe, calculating your net worth is simple. How much money do you have in your bank account? Subtract your liabilities (debt) from your assets (money and possessions), and there you go.
However, if you’re an entrepreneur, the process can get foggy. Many entrepreneurs have no idea what they’re worth because they tie their business’ value into it, throwing off complications.
Here’s how the rationale often goes: over the past few years, you’ve built a business from the ground-up. Now, it does $3.5 million per year in business. The fallacy that entrepreneurs fall into is believing that they themselves are worth $3.5 million, when their personal value is much smaller.
They Can’t Separate Personal from Professional
You need to realize this right now. You are not your business. Putting your entire financial worth into your business is a good idea... until it isn’t.
That motivation and confidence is good, but investing 100% of your capital into your business is truly not a wise move. So many entrepreneurs do this when they get that first idea that, in their mind, is sure to be a winner. This leads to a complete miscalculation of what the entrepreneur himself is actually worth.
You will never attain financial independence on your business balance sheet. Financial independence has be built on your personal balance sheet.
In order to truly be successful and make decisions based on accurate data, you need to mentally and financially differentiate yourself from your business.
Calculating your business’ worth is a completely separate process and one that will yield a wildly different result. While you can tie yourself emotionally and physically to your business, working all the hours necessary, do not commit the fatal flaw of binding your personal finances with your business finances.
Another fallacy many entrepreneurs commit is basing their net worth on what they’d take to sell their business, which is a wholly inaccurate number. If their business is worth $5 million, but it would take $6 million to pry it from their hands, that does not mean the business owner has a net worth of $6 million.
The separation of business and personal is a necessary must, and failing to do this is often the first misstep for many entrepreneurs.
They Have No Idea Where They Are Financially
When you don’t know your net worth, you have no idea how much money you need to live the lifestyle you want. Imagine using a GPS, but not putting in a starting point. You could be 3 miles from your goal or you could be 3,000 — but you have no idea.
The first step to living the life you dream of is figuring out where you’re starting out. Figuring out your personal net worth, separate from your business, is the first step toward that lifestyle.
The only real number that matters for entrepreneurs, in terms of personal net worth, is what is on the personal balance sheet. That’s what you’re measuring your debts against.
Whether you just want to be able to pay bills and escape the paycheck-to-paycheck life or you desire a superfluous lifestyle with so many luxuries, you’ll never know how to get there if you don’t set a starting point.
So where do entrepreneurs go wrong?
They Don’t Know What an Asset Really Is
When you go to a bank to start figuring out your net worth, they’ll calculate things that benefit them as collateral: your house, car, boat of things of that nature. As an entrepreneur, the only things you should be including in calculations are the things that are assets to you, not just collateral to a bank..
I’d take it a step further. Don’t just include any asset, but those that can generate cash flow. I define an asset as something that can be used to put money in your pocket now (or in the future) without changing your lifestyle.
Here are some things that should not be considered personal assets:
- Your personal residence
- Your business
- Your antiques
- Your jewelry
- Your car
When I tell this to entrepreneurs, they are shocked. They live in a multi-story house with a Maserati in the garage, but the prudent business owner living in a one-bedroom efficiency apartment could have more assets (by our definition) than them.
If this has been a wake-up call, that is a good thing. You know the saying, “The best time to plant a tree was 20 years ago. The second best time is now”?
Here’s how it applies to entrepreneurs: “The best time to assess your net worth was before you built your business. The second best time is now.”
You will never build financial independence on your business balance sheet. You will only have financial independence when it is on your personal balance sheet.