There are many different ways to evaluate one’s finances.  But three measurements are critical: Net Worth, Liquid Net Worth and Debt / Income Ratio.

The most basic way to calculate one’s net worth (from a financial perspective) is to simply subtract one’s liabilities from one’s assets. 

Assets can be cash, retirement accounts, real estate, cars, jewelry, and other items of monetary value.

Liabilities can be credit card debt, home mortgage debt, student loans, car loans or other situations where one owes money.

Net Worth = Sum of Assets – Sum of Liabilities.

A better measure of a person’s financial situation is their “liquid net worth” because it helps people plan for emergencies.

This measure takes into account that some assets are liquid, or easy to convert into cash, and others are not.  Examples of liquid assets are cash, stocks, or a retirement account.  Note this does not include items like a house or a car, because those are not quickly convertible into cash.

Liquid Net worth = Sum of Liquid Assets – Sum of Liabilities. 

Note that a net worth calculation does not include any measure of one’s income.  A measure known as the debt to income ratio is very important to evaluate one’s financial situation.

In order to compute this ratio one adds up all their monthly debt payments. (Car Loan, Rent, Student Loan, etc.) and then divides that by one’s gross monthly income.

Debt / Income Ratio = Sum of Monthly Debt Payments / Gross Monthly Income. 

This will give you a number that is then converted into a percentage.  In general, the lower the percentage, the better the financial condition. Clearly, if one’s monthly debts are greater than one’s monthly income, one will struggle financially.

These three simple measurements can give a person good insight into their financial net worth.