You know what assets are, right? They’re what you own. And liabilities? What you owe.
That’s the traditional, “back-of-the-envelope” definition.
Could this definition not only be wrong, but seriously misleading and damaging?
I think so!
As with what I wrote about in my last post, it’s been family banking advisors who put me in touch with this alternative way of looking at things. First, by way of my business.
They urged me to study something called EVA–Economic Value Added. And I decided to “dive deep” using a book titled Best-Practice EVA by Bennett Stewart.
There, right at the start of Chapter 3 (“Accounting for Value”), Stewart has the temerity to suggest generally accepted accounting practices (“GAAP”) are dangerous; they are “flagrantly at odds with economic reality.”1
[A]ccounting statements cater to lenders rather than owners. Lenders want to get repaid even in the worst of circumstances, when the business has failed and it is a question of liquidating what’s left of the carcass. Accounting rules create balance sheets that . . . show the value that might be realized in a salvage sale.
But if we remove ourselves from the depressing company of Scrooge and Marley (the creditor class) and join the scintillating society of shareholders (the owner/proprietor class), the balance sheet changes before our eyes. As shareholders and as corporate managers, we are chiefly concerned with the company’s performance and its value as a going-concern business enterprise. And from that perspective, we never expect to fully liquidate the assets. We need them to run our business—which means, strange as it may seem, that so-called assets aren’t really assets at all. They are liabilities.
Assets tie up capital that must be financed at the cost of capital. A firm that ties up more assets on its balance sheet is perhaps more bankable—there’s a greater reserve of blubber to cushion a fall—but as a business enterprise, it is less valuable than a leaner outfit that earns the same profit with fewer assets.2
As a business owner, I understood what he was talking about.
A year or two later, I finally came into the orbit of Robert Kiyosaki, perhaps best known as the author of Rich Dad, Poor Dad. Good as that particular book is, personally, I have been more impacted by his Rich Dad’s Cashflow Quadrant. In either case, he says the same thing about assets and liabilities. It’s a teaching he repeats over and over.
From his perspective,
“An asset puts money into my pocket.
A liability takes money out of my pocket.”
It’s not what the thing might be worth if. It’s what the thing does. . . .
And so. Your house: cash into your pocket? Or out of your pocket?
Your car: cash in or out?
Your cell phone: in or out?
Your computer? . . .
How about the things you consider to be investments? . . .
How’s this for a shot across the bow?
The fact is, when a banker tells you your house is an asset, they are not really lying to you. They’re just not telling you the whole truth. While your house is an asset, they simply do not say whose asset it is. For if you read financial statements, it is easy to see that your house is not your asset. It’s the bank’s asset.3
Now. Before I let extreme statements be taken for truth, let me note that Kiyosaki and Stewart both slightly–but, overall, I would say, just slightly–overstate things.
Ultimately, it is not true that absolutely all “so-called assets aren’t really assets at all” (see Stewart quote, above). And nor is it always the case that your house is the bank’s asset and not your asset just because they hold a mortgage on it.4
These are your assets, to some degree, even if they don’t put money into your pocket. But they are certainly better assets if they provide positive cash flow (i.e., money moving into your pocket5).
But whether your assets are oriented at this time to moving money in or taking money out, there is an entire realm of analysis that most financial consultants ignore when it comes to assets and liabilities. They ignore this matter of cash flow. And they ignore the degree to which these assets are, indeed, cash flow assets to others and not to you. (They are not cash flow assets to you to the extent that they are flowing cash away from you and toward these other parties.)
They ignore these realities, don’t they? When was the last time your financial advisor discussed how you might recover cash flow that is currently moving away from you?
To the extent that your advisors leave you ignorant of the value you could be receiving but are failing to get, to the extent that you are blind to what these other parties are acquiring at your expense, you will never think to discover how you might lay hold of what you are missing . . . and you will continue to miss it (without realizing what you are missing).
1 Kindle Location 1388. Return to text.
2 Kindle Location 1394. Return to text.
4 Indeed, as I have discovered–shockingly!–letting the bank hold a mortgage on your house may actually increase the value of the house to you. But that is a subject for a different time. Return to text.
5 Vs. negative cash flow, which is money moving out of your pocket. Return to text.