What Is Net Worth?
Net worth is the value of the assets a person or corporation owns, minus the liabilities they owe. It is an important metric to gauge a company's health, providing a useful snapshot of its current financial position.
- Net worth is a quantitative concept that measures the value of an entity and can apply to individuals, corporations, sectors, and even countries.
- Net worth provides a snapshot of an entity's current financial position.
- In business, net worth is also known as book value or shareholders' equity.
- People with substantial net worth are called high-net-worth individuals (HNWI).
What is Net Worth?
Understanding Net Worth
Net worth is calculated by subtracting all liabilities from assets. An asset is anything owned that has monetary value, while liabilities are obligations that deplete resources, such as loans, accounts payable (AP), and mortgages.
Net worth can be described as either positive or negative, with the former meaning that assets exceed liabilities and the latter that liabilities exceed assets. Positive and increasing net worth indicates good financial health. Decreasing net worth, on the other hand, is cause for concern as it might signal a decrease in assets relative to liabilities.
The best way to improve net worth is to either reduce liabilities while assets stay constant or rise, or increase assets while liabilities either stay constant or fall.
Types of Net Worth
Net worth can be applied to individuals, companies, sectors, and even countries.
Net Worth in business
In business, net worth is also known as book value or shareholders' equity. The balance sheet is also known as a net worth statement. The value of a company's equity equals the difference between the value of total assets and total liabilities. Note that the values on a company's balance sheet highlight historical costs or book values, not current market values.
Lenders scrutinize a business's net worth to determine if it is financially healthy. If total liabilities exceed total assets, a creditor may not be too confident in a company's ability to repay its loans.
A consistently profitable company will register a rising net worth or book value as long as these earnings are not fully distributed to shareholders as dividends. For a public company, a rising book value will often be accompanied by an increase in the value of its stock price.
Net Worth in personal finance
An individual's net worth is simply the value that is left after subtracting liabilities from assets.
Examples of liabilities, otherwise known as debt, include mortgages, credit card balances, student loans, and car loans. An individual's assets, meanwhile, include checking and savings account balances, the value of securities such as stocks or bonds, real property value, the market value of an automobile, et al. Whatever is left after selling all assets and paying off personal debt is the net worth.
Note that the value of personal net worth includes the current market value of assets and the current debt costs.
People with a substantial net worth are known as high net worth individuals (HNWI), and form the prime market for wealth managers and investment counselors. Investors with a net worth, excluding their primary residence, of at least $1 million—either alone or together with their spouse—are "accredited investors" in the eyes of the Securities and Exchange Commission (SEC), and, therefore, permitted to invest in unregistered securities offerings.
Net Worth Example
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.
- 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.
To calculate your net worth, use our free Net Worth Tracker, which allows you to calculate, analyze, and record your net worth for free.
Negative net worth
A negative net worth results if total debt is more than total assets. For instance, if the sum of an individual's credit card bills, utility bills, outstanding mortgage payments, auto loan bills, and student loans is higher than the total value of their cash and investments, net worth will be negative.
Negative net worth is a sign that an individual or family needs to focus its energy on debt reduction. A tough budget, use of debt reduction strategies such as the debt snowball or debt avalanche, and perhaps negotiation of some debts with creditors can sometimes help people climb out of a negative net worth hole and start building up their resources. Early in life, a negative net worth is not uncommon—student loans mean even the most careful-with-money young people can start out owing more than they own. Family responsibilities or an unexpected illness can also push people into the red.
When nothing else has worked, filing for for bankruptcy protection to eliminate some of the debt and prevent creditors from trying to collect on it might be the most appropriate solution. However, some liabilities—such as child support, alimony, taxes, and often student loans—cannot be discharged. It’s also worth bearing in mind that a bankruptcy will stay on an individual's credit report for many years.