Net Worth: What It Is and How to Calculate It

• Net worth is a quantitative concept that assesses an entity's value and can be applied to individuals, corporations, industries, and even countries.
• The net worth of an entity provides a snapshot of its current financial position.
• Net worth is also known as book value or shareholders' equity in the business world.
• Individuals with a considerable net worth are referred to as high-net-worth individuals (HNWI).
• Currently, Elon Musk has the highest net worth of any individual on earth.

How to Calculate Net Worth

To calculate net worth, deduct all liabilities from assets. A liability is an obligation that depletes resources, such as loans, accounts payable (AP), and mortgages.

The net worth can be positive or negative, with positive indicating that assets exceed liabilities and negative indicating that liabilities exceed assets. A net worth that is positive and growing is indicative of sound financial health. However, decreasing net worth is cause for concern because it may indicate a decline in assets relative to liabilities.

Either decreasing liabilities while assets remain constant or rise, or increasing assets while liabilities remain constant or fall, is the best method to increase net worth.

The concept of net worth can be applied to individuals, companies, industries, and even nations.

Net Worth in Business

Net worth is also known as book value or shareholders' equity in the business world. The balance sheet is also known as the statement of net worth. The value of a company's equity equates the difference between the value of total assets and total liabilities. Note that the values on the balance sheet of a company reflect historical costs or book values, not current market values.

Lenders examine the net worth of a business to determine its financial health. If total liabilities exceed total assets, a creditor might not have much faith in a company's capacity to repay loans.

A consistently profitable company's net worth or book value will increase so long as these profits are not entirely distributed as dividends. A rising book value for a public company is frequently accompanied by an increase in the stock price.

Net Worth in Personal Finance

A person's net worth is the amount remaining after subtracting liabilities from assets.

Debts such as mortgages, credit card balances, student loans, and auto loans are examples of liabilities. In addition to invoices and taxes, liabilities can also include other obligations that must be satisfied.

The assets of an individual include balances in checking and savings accounts, the value of securities such as equities or bonds, the value of real property, the market value of an automobile, etc. Net worth is the amount remaining after selling all assets and paying off personal debt.

High net worth individuals (HNWI) are the primary target market for wealth managers and investment counselors. In the eyes of the Securities and Exchange Commission (SEC), investors with a net worth of at least $1 million, excluding their primary residence, are "accredited investors" and are therefore permitted to invest in unregistered securities offerings.

Example of Net Worth

Consider a couple with the following assets:

• Primary residence valued at $250,000,
• An investment portfolio with a market value of $100,000,
• Automobiles and other assets valued at $25,000.

Liabilities include:

• An outstanding mortgage balance of $100,000
• A car loan of $10,000

The couple's net worth would, therefore, be calculated as:

[$250,000 + $100,000 + $25,000] - [$100,000 + $10,000] = $265,000

Assume that five years later, the couple's financial position changes: the residence value is $225,000, investment portfolio $120,000, savings $20,000, automobile and other assets $15,000; mortgage loan balance $80,000, and car loan $0 because it was paid off. Based on these new figures, the net worth five years later would be:

[$225,000 + $120,000 + $20,000 + $15,000] - $80,000 = $300,000.

The couple's net worth has gone up by $35,000, despite the decrease in the value of their residence and car. As we can see above, these declines were more than offset by increases in other assets, in this case, the investment portfolio and savings, as well as a drop in liabilities owed.

Negative Net Worth

Negative net worth results when total liabilities exceed total assets. For example, if a person's credit card bills, utility bills, outstanding mortgage payments, auto loan bills, and student loans exceed the total value of their cash and investments, their net worth will be negative.

Negative net worth indicates that an individual or family should prioritize debt reduction. A strict budget, the application of debt reduction strategies such as the debt snowball or debt avalanche, and possibly the negotiation of some debts with creditors can sometimes assist individuals in climbing out of a negative net worth pit and beginning to build their resources.

Early in life, it is not uncommon to have a negative net worth; student loans mean that even the most frugal young adults can begin by owing more than they own. Family obligations or an unanticipated illness can also drive individuals into the red.

Filing for bankruptcy protection to eliminate some of the debt and prevent creditors from attempting to collect on it may be the best option when nothing else has worked; however, certain liabilities, including child support, alimony, taxes, and frequently student loans, cannot be discharged. It is also important to remember that a bankruptcy will remain on a person's credit report for many years.

The Bottom Line

The net worth of an individual or company is a useful measure of their underlying wealth. Due to the fact that assets are frequently negated by liabilities, such as debt, it can be misleading to consider only a person's assets. Therefore, one's net worth can be increased by increasing assets and decreasing debts and other liabilities.

Also read :- Revenue vs. Profit: What's the Difference?