For a company or business, Net worth means the value of assets it owns minus the liabilities it owes. It’s also sometimes referred to as Net Wealth, Book Value or shareholder’s equity.
Net worth provides a snapshot of current financial position.
To calculate Net worth of a company, you subtract all liabilities and subtract all assets that they are showing on the balance sheet. Simply put, Net worth refers to what a business owns minus what it owes.
If the Net worth is positive, then it means all assets exceed all liabilities, meaning the business is on track to building wealth. Negative Net worth indicates all liabilities exceeded all assets.
The formula to calculate Net worth is a simple one:
Net Worth = Assets – Liabilities, or
What the business own – what they owe
Here are the steps to follow for calculating net worth;
- take all the assets from the organization’s balance sheet like fixed assets, cash balance , money in bank and current assets.
- Take total liabilities of the business from its balance sheet like current liabilities, long term liabilities and others.
- After getting total assets and total liabilities, use the above formula to determine the net worth.
Why is Net worth important?
Here are important reasons why monitoring net worth of a business is important;
- It gives a clear picture of a company’s financial situation by showing the difference between what the business owns and what the business owes.
- By regularly calculating net worth, anyone can track progress of financial health over time.
- Lenders scrutinize a businesses’ net worth in order to know whether it’s financially healthy. Good net worth will attract more lenders with better interest rates.
- Creditor wants to know whether a credit facility should be given to a company. Companies with good financial health will attract more vendors with a good bargain power.
Rising net worth of a company will often indicate increase in value of listed stock price.
Net worth in Personal Finance
Similar to a company or business, an individual’s net worth is calculated by subtracting liabilities from assets. In this case, you take all personal liabilities and assets to calculate Net worth.
In simple terms, individual net worth means the difference between what they own and what they owe.
It provides a snapshot of an individual’s financial situation at a particular point of time.
If an individual’s assets exceed their liabilities, they have a positive net worth.
Conversely, if the liabilities are higher than assets, the net worth will be negative.
An individual’s asset will include followings;
- Bank balance
- Value of securities such as stocks, bonds
- Mutual funds
- Market value of your home, rental properties, land
- Business ownership
- Insurance policies with cash value
- Market value of cars
- Jewelry
Assets are the financial instruments and things that an individual owns.
Liabilities of an individual will include followings;
- Credit card bills,
- Auto loans,
- Utility bills,
- Student loans, and
- Outstanding mortgage payments.
Liabilities represent an individual’s obligation or what he/she owes to other people or organizations.
Negative net worth means liabilities are more than assets.
Example showing calculation of individual’s net worth
Suppose an individual has following assets and liabilities.
Assets:
- Cash: Rs 50,000
- Investments: Rs 2,00,000
- Real Estate: Rs 15,00,000
- Personal Property: Rs 10,00,000
- Deposits: Rs 10,00,000
Total assets = Rs 37,50,000
Liabilities:
- Home loan: Rs 10,00,000
- Auto Loan: Rs 8,00,000
- Credit Card Debt: Rs 20,000
- Student Loans: Rs 1,50,000
Total Liabilities = Rs 19,70,000
Net worth = Total assets – total liabilities = Rs 37,50,000 – Rs 19,70,000 = Rs 17,80,000
In this example, the net worth would be Rs 17,80,000.
Net worth is a valuable tool for understanding financial health. However, you should consider other financial metrics in order to assess a business or individual.
Also Read: What happens when RBI raises interest rates
