Net Worth-Meaning,Types of Net Worth,Examples,Negative Net Worth (Commerce Achiever)

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.

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 shareholder’s 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.

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.

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

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.

Bankruptcy protection to eliminate some of the debt and prevent creditors from trying to collect on it. However, some liabilities, such as child support, alimony, and taxes, cannot be discharged. It’s also worth bearing in mind that a bankruptcy will stay on an individual’s credit report for many years.