Balance sheet basics

balance sheet lists an individual’s or family’s assets and liabilities. The use of the balance sheet, also called a statement of financial position, is a simple exercise in financial planning best conducted annually by every household (and investor and businessperson).

Common situations involving the use of a balance sheet include:

  • a buyer applying for purchase-assist financing with a mortgage lender;
  • a buyer seeking seller carryback financing;
  • a homeowner intending to refinance;
  • a distressed homeowner requesting a mortgage modification; and
  • a commercial landlord screening a tenant.

The balance sheet assists a lender — or seller, in the case of carryback financing — in determining the creditworthiness of a buyer when reviewing a financing application. It is incorporated into the standard loan application lenders use as part of the analysis for mortgage qualification. It is also part of the hardship package a homeowner provides their mortgage holder when requesting a mortgage modification when they are unable to fulfill their repayment obligations.

The balance sheet analysis also reveals a homeowner’s financial state — whether they are on track to meet their long-term financial goals, or whether they’ve been derailed by recent events. Simply, it identifies assets and liabilities, and distinguishes the critical relationship between the two.

Related article:

Brokerage Reminder: Carryback financing – the creditworthy buyer and mandated disclosures

Assets vs. liabilities

Assets are tangible and intangible things of value held by an individual or family. Among them are liquid assets — which take the form of cash or something easily converted to cash, and include money held in a savings account or tradable stocks and bonds. [See RPI Form 209-3 §1 and 2]

Typically, the largest dollar-valued asset a homeowner will ever own is their home. It is historically considered an illiquid asset as its equity cannot quickly be converted to cash. With a positive equity stake in the home, the owner treats it as a valued asset and thus maintains and improves it. Over time, the property’s equity buildup can be cashed out by selling the property or obtaining further financing.

Other items that make up a homeowner’s assets include:

  • funds held in retirement accounts;
  • ownership interests in businesses;
  • trust deed notes owned;
  • vehicles, furniture and equipment owned; and
  • any other item of recognized value, such as collectibles. [See RPI Form 209-3 §5 through 9]

Liabilities are the flip-side of the financial coin. Together, liabilities and net (or negative) worth are equal to the value of the assets. The formula is:

  • assets minus liabilities equals net worth (assets – liabilities = net worth).

Liabilities included in a balance sheet are financial obligations and debts owed to others, including:

  • real estate mortgages;
  • auto loans;
  • credit card balances;
  • alimony/child support/lease payments; and
  • loans collateralized by stocks, bonds or notes. [See RPI Form 209-3 §11 through 15]

An individual or family’s net worth is revealed when their total liabilities are subtracted from the current fair market value (FMV) of their assets. When net worth is positive, the homeowner is worth more than what is owed to creditors. In other words, the homeowner is solvent.

The balancing act between assets and liabilities is immediately upended when a high-value asset, such as the homeowner’s residence, has a negative equity. If the negative equity is large enough, the value of the homeowner’s other assets is overwhelmed. Thus, their net worth appears as a negative figure — a measure of insolvency.

An agent may assist homeowners who complete the balance sheet by being available to answer questions about the home’s market price and rental value. Availability and awareness is all part of an agent’s standard farming practice within a particular community. This builds long-term goodwill which will benefit the agent when the homeowner next considers a real estate transaction.

The agent may enter their contact information at the bottom of each page of the balance sheet, ensuring that whenever the homeowner refers to the balance sheet, they will be reminded of that goodwill. Thus, when the homeowner next needs representation, the real estate expert who advised them on price and values will be the first agent to come to mind — and the agent who will get a fee.