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.

  1. Subordinated Debt

    Subordinated Debt is a loan or security that ranks below other ...
  2. Subordinate Financing

    Subordinate financing is debt financing that is ranked behind ...
  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. Bank Capital

    Bank capital is the measurement of a bank's assets minus its ...
  6. Preferred Debt

    Preferred debt refers to debt obligations that must be repaid ...
Related Articles
  1. Investing

    Why Knowing Your Net Worth Is Important

    Regardless of your financial situation, knowing your net worth can help you evaluate your current financial health and plan for your financial future.
  2. Personal Finance

    Before Taking on Debt, Ask These Questions

    To understand the difference between good and bad debt, ask these questions before borrowing money.
  3. Investing

    Understand the Security Types of Corporate Bonds

    Any investor should be aware of the different security types regarding corporate bonds as well as the direct correlation to potential recovery rates.
  4. 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.
  1. What are the different ways corporations can raise capital?

    Find out about raising capital for corporations with debt and equity capital. Learn how interest and dividend payments factor ... Read Answer >>
Trading Center