What is 'Effective Net Worth'

Effective net worth is shareholders' equity plus subordinated debt. From the viewpoint of senior creditors, adding subordinated debt, in effect, increases a company's net worth. Effective net worth is particularly useful in analyzing closely held corporations. Executive officers of these companies often have a significant ownership stake and have made loans to the company. These loans are considered subordinated debt, which ranks lower in priority than senior debt. Holders of subordinated debt are among the last to recover their investment if the company defaults. Subordinated debt can also include debentures.

BREAKING DOWN 'Effective Net Worth'

For senior creditors, loans to the company by its owners are considered, in effect, as an addition to the company's net worth because as subordinated debt held by the owners, it does not appear much different from equity. From the perspective of a senior creditor, both subordinated debt and shareholder's equity rank lower in priority in making a claim on assets in the event of default. In addition, for company owners who have also made loans to the company, the risk of loss is also similar on both the loans and the equity.

If a closely held corporation with total assets of $10 million and total liabilities of $6 million, then the company would have or net worth of $4 million. Assume total liabilities include subordinated loans such as debentures and loans from owners of $1 million. Effective net worth in this case would be: $4 million + $1 million = $5 million.

If you're looking to track your personal net worth, use our free Net Worth Tracker which allows you to calculate, analyze and record your net worth for free.

RELATED TERMS
  1. Subordinated Debt

    Subordinated Debt is a loan or security that ranks below other ...
  2. Perpetual Subordinated Loan

    A perpetual subordinated loan is a type of junior debt that continues ...
  3. Convertible Subordinate Note

    A convertible subordinate note is a short-term debt security ...
  4. Net Worth

    Net worth is a concept applicable to individuals and businesses ...
  5. Preferred Debt

    Preferred debt refers to debt obligations that must be repaid ...
  6. Debt Restructuring

    Debt restructuring is a method used by companies with outstanding ...
Related Articles
  1. Investing

    The importance of knowing your net worth

    It is vital that you track your net worth (the difference between what you own and what you owe), no matter what your age.
  2. Personal Finance

    Common Liabilities That Hurt Your Net Worth

    Every penny that you keep out of the liability side of the net worth equation essentially ends up on the asset side.
  3. Investing

    Will Corporate Debt Drag Your Stock Down?

    Corporate debt can mean a leg up for firms, or the boot for investors. How to tell the difference.
  4. Retirement

    Why You Should Know Your Net Worth In Retirement

    Just because you are comfortably in retirement, that doesn't mean you should stop keeping track of your net worth.
  5. Retirement

    Why Retirees Are Carrying More Debt Than Ever

    As people reach retirement they are carrying more debt than ever before. Why and what to watch for.
  6. Personal Finance

    Ways to Destroy Your Net Worth

    Many people fall victim to these mistakes, and they can drastically affect a person's net worth in a negative way.
RELATED FAQS
  1. Why would you look at a company's net debt rather than its gross debt?

    Learn the difference between net debt and gross debt, how to calculate debt using a company's financial statements and why ... Read Answer >>
  2. What are some examples of debts that I can consolidate?

    Read about different kinds of debts than can be combined into a consolidation loan, including unsecured debts, secured debts ... Read Answer >>
Hot Definitions
  1. Return On Equity - ROE

    The profitability returned in direct relation to shareholders' investments is called the return on equity.
  2. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  3. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  4. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  5. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  6. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
Trading Center