Tuesday, September 18, 2007

Are Credit Card Bills Considered an Asset?

Through effective money management strategy, it is possible to improve your net worth by hundreds of thousands of dollars over the long term. As part of the wealth creation process, you must be able to distinguish between assets, liabilities and equity. A credit card bill is technically a liability. Individual items on your credit card bill, however, can represent assets that you bought to generate wealth.

Balance Sheet

    You can define the accounting equation as assets equal liabilities plus equity. Equity can be described as financial ownership, or net worth. As a private individual or business operator, your ultimate goal would be to increase your net worth--for a manageable amount of risk. To do so, you work to increase your assets and decrease your liabilities over time.

Liabilities

    A liability, such as a credit card balance, is a debt you owe and must be paid back. In most cases, you will repay the liability with interest--to compensate your lender for putting up cash for you to spend. A credit card is a type of unsecured debt, where the bank relies upon good faith in you to make timely loan payments. Because of these terms, credit cards expose lenders to relatively high amounts of risk. In exchange for taking on more risks, credit card companies charge high interest rates. Alternatively, a mortgage is an example of a secured loan that is backed by real estate collateral. The lender can seize the home and sell it to make good on missed payments that result in mortgage default. For banks, these collateral provisions reduce risks for mortgages and translate into relatively low interest rates.

Assets vs. Consumer Items

    Credit cards can be used to purchase both assets and consumer goods. Assets are items that have value, generate income and can be sold for cash. For example, you can put computer equipment on a credit card while you are in the process of establishing a start-up business. With the computer equipment assets, you can design marketing materials to generate income for your business. Alternatively, consumer goods and services do not generate income and are rarely sold for cash. Designer jeans and fine restaurant dining would, therefore, be examples of consumer items you put on your credit card.

Strategy

    Excessive consumer spending can lead to large credit card balances, expensive interest charges and even financial distress. You should eliminate discretionary spending from your budget altogether, if you are struggling to pay bills on time. When managing liabilities, you should prioritize payments according to interest rates. For example, you should spend an extra $1,000 to pay off a 15 percent interest rate credit card, instead of putting the money toward extra principal payments on a 6 percent mortgage.

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