What Is Net Worth?
Net worth is the measure of wealth of an entity, person, or corporation, as well as sectors and countries. Simply, net worth is defined as the difference between assets and liabilities. It is an important metric to gauge a company's health and it provides a snapshot of the firm's current financial position.
What is Net Worth?
Understanding Net Worth
Net worth is calculated by subtracting all liabilities from assets. An asset is anything owned and has monetary value, while liabilities are obligations that deplete resources. Positive net worth means that assets exceed liabilities, while negative net worth results when liabilities exceed assets. Positive and increasing net worth indicates good financial health while decreasing net worth 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.
- 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. The balance sheet is also known as a net worth statement.
- People with substantial net worth are known as high-net-worth individuals (HNWI).
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 have a rising net worth or book value as long as these earnings are not fully distributed to shareholders as dividends. For public companies, rising book values may be rewarded with an increase in the value of stocks trading in the markets.
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 (debt) include mortgages, credit card balances, student loans, and car loans. An individual's assets include checking and savings account balances, the value of securities (e.g., stocks or bonds), real property value, the market value of an automobile, et al. In other words, 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" by the Securities and Exchange Commission (SEC), 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, and automobiles and other assets valued at $25,000. Liabilities are an outstanding mortgage balance of $100,000 and 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 (paid off). The net worth five years later would be [$225,000 + $120,000 + $20,000 + $15,000] - $80,000 = $300,000.
In other words, the couple's net worth has gone up by $35,000 despite the decrease in the value of their residence and car. The increase in net worth is because the decline in residence value was more than offset by increases in other assets (e.g., investment portfolio and savings), as well as the decrease in liabilities.
A negative net worth results if total debt is more than total assets. For example, 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 his cash and investments, his net worth will be negative. In this case, the individual may file for Chapter 7 bankruptcy protection to eliminate some of the debt and prevent creditors from trying to collect on the debt. However, some liabilities, such as child support, alimony, and taxes, cannot be discharged. Also, a bankruptcy will stay on an individual's credit report for many years.
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