Net Worth

Known as net wealth - is how much value a company, person, or government has, in dollar terms

Net worth - also known as net wealth - is how much value a company, person, or government has, in dollar terms. It is basically the value of all assets the entity owns minus all the liabilities it owes.

Net worth

This concept can pretty much apply to any entity that can own assets and liabilities. The result of this calculation is known as the net worth. Nowadays, this metric has become very popular for comparing different personalities and celebrities to find out who has the largest net wealth.

In the case of companies, It is a crucial indicator for assessing a company's health because it offers a helpful overview of its present financial situation. For companies, it can also be referred to as owners' equity, the book value of a company, net book value, and net assets.

It is also useful for an individual to know their own net wealth. This is because it can provide useful insight into what investment strategies one is available to pursue. Different levels of net wealth may have different suitable investment portfolios to build.

For example, someone may find it best to invest in lower-risk financial products to avoid risking his or her wealth. Other individuals with higher net worths and highly liquid net assets can become "accredited investors" and invest in hedge funds and other unregistered securities offerings.

Governments and countries also have net worths which can convey a lot of information regarding public debt. It can be used as a proxy to measure net government debt, just like gross debt. Net debt is gross debt minus financial assets corresponding to debt instruments.

Calculating net wealth is roughly similar for all entities: subtracting outstanding liabilities owed from all outstanding assets owned. There are some intricacies that come along with different economic entities, all of which are going to be discussed further in the article.

Net worth of companies

It is more commonly known as shareholders' equity. Shareholders' equity is equal to the assets of a company minus the liabilities of that company. Assets represent what the company owns, while liabilities represent what the company owes.

Magnifying Glass

If a business succeeds, its profits rise, and shareholders' equity increases. Owners' equity increases because of a section in the balance sheet called retained earnings. A company's shareholders' equity is divided into two main sections.

  1. Direct capital investment from investors and shareholders

  2. Retained earnings, which are known to be an indirect investment. They are the profits that are reinvested in the company and not distributed as dividends to shareholders. 

It is crucial to understand the difference between the net worth and the market value of a company. Both have to do with the value of a company or the value of an investor's ownership stake in a business. 

The main distinction is that market value, as opposed to net wealth, is the price that a buyer is actually willing to pay for the company. Net wealth takes an accounting perspective, looking at historical costs, while market value takes a financial perspective, looking at prices in a market.

For example, as of the end of 2021, Google had a net worth - or book value - of $255.41 billion, compared to its market value of $1.97 trillion. It is almost always the case that the market value of large corporations is much greater than their book value.

According to the balance sheet, net value turns negative if compounded losses surpass shareholder equity. It is also important to distinguish tangible net worth, which is the tangible assets of the company minus its liabilities.

Assets of a company

Assets refer to anything that has a value controlled by an entity that expects future benefits from those resources. Assets are usually acquired to create value in the company. All assets owned by a company are listed in its balanced sheet.

Calculator

An asset can create value in different ways:

  • It can produce future cash inflows

  • It can decrease the costs of a firm's operations

  • It can boost revenue

The basic categories of assets are:

  • Current assets

  • Fixed assets

  • Financial assets

  • Intangible assets

Regardless of their type, all assets are expected to provide certain economic benefits in the future. All these benefits will aim to increase the book value of a company. The more assets a company owns, the higher the net value that company will have.

1. Current assets:

Some assets are regarded as current assets in accounting. Current assets are short-term resources that are expected to be used up or liquidated within a year. Examples of current assets are cash and cash equivalents, receivables, inventories, and different prepaid expenses.

It is important to note that most of these assets are recorded in the balance sheet according to their historical cost. This means that the value of the assets in the assets section in the balance sheet reflects the dollar amount for which it was bought and not its actual value in the market.

2. Fixed assets:

Fixed assets have a useful life of longer than a year after being written off. Most fixed assets undergo an accounting adjustment called depreciation. Depreciating a fixed asset requires allocating a periodic cost on using the asset.

Parking lot

That being said, it does not always reflect how much the fixed assets have lost their efficiency. That is why there are several methods of depreciating an asset depending on its use throughout its life, in addition to the different tax benefits it can bring to the business.

3. Financial assets:

The most liquid resources for a firm are its financial assets. Cash, cash equivalents, specific investments in marketable securities, accounts receivable, and notes receivable are among them. These can be promptly converted into known amounts of cash.

4. Intangible assets:

Assets that are utilized in the operation of the business but have no physical features and are noncurrent are referred to as intangible assets. Patents, copyrights, trademarks, franchises, and goodwill are a few examples.

Liabilities of a company

Liabilities are known to be financial obligations or debts. All liabilities are expected negative future cash flows for a company. The bank or organization that has provided the debt is known as a creditor. 

Tool

Every company is bound to have liabilities listed on its balance sheet. This is because most large purchases are made "on account", which means it buys the goods and inventories on credit. The liabilities associated with such purchases on account are called accounts payable.

Another very important item in the liabilities section of a balance sheet is called notes payable. Many companies take out loans to fund growth or the long-term acquisition of expensive assets (like a property). The borrower typically has to sign a formal note payable in order to get a loan.

A note payable is a formal commitment to pay back the debt by a specific date and typically includes interest as well. Accounts payable, on the other hand, are not characterized by formal agreements and do not require interest payments.

Liabilities can also be divided into current or noncurrent, depending on how soon the debt must be repaid. Accounts payable may be classified as current liabilities and notes payable may be regarded as noncurrent liabilities.

1. Current liabilities:

An existing debt or obligation that a business anticipates paying off within a year is referred to as a current liability. Typically, it uses its current assets, like cash and cash equivalents, in order to repay current liabilities.

Other items in the current liabilities section include:

2. Noncurrent liabilities:

As the name suggests, noncurrent liabilities are repayment and settlements that are expected to be made after more than a year. Any long-term debt the company has taken on is listed in the long-term liabilities section of the balance sheet.

Debt

Other items in the noncurrent liabilities section include:

  • Debentures

  • Long-term loans

  • Bonds payable

  • Deferred tax liabilities

Calculating the net worth of a company

Now that we know what the assets and liabilities of a company are composed of, we should be able to calculate the book value of the business. As previously mentioned, it is equal to the total assets owned by the company minus the total liabilities it owes to creditors.

Arrow

The resulting number will also be equal to the stockholders' equity, which is regarded as the residual value of the assets after all settlements (liabilities) are paid. 

It is always important to know this figure, as it provides a general interpretation of the company's overall financial health.

Let us look at an example. Suppose a hardware store has the following simplified balance sheets:

December 31, 2020 December 31, 2021 
Assets Assets 
Cash and cash equivalents$20,000Cash and cash equivalents$37,000
Accounts receivable7,500Accounts receivable7,000
Shop supplies1,500Shop supplies1,800
Land60,000Land60,000
Building net of depreciation43,000Building net of depreciation40,000
Equipment net of depreciation10,500Equipment net of depreciation10,000
Total Assets$142,500Total Assets$155,800
Liabilities Liabilities 
Accounts payable3,000Accounts payable4,000
Notes payable12,000Notes payable12,000
Wages payable2,500Wages payable4,500
Unearned rent revenue6,000Unearned rent revenue4,000
Total Liabilities$23,500Total Liabilities$24,500

 

In order to calculate it, all we have to do is to subtract total liabilities from total assets. At the end of 2020, we can find that the net book value of the company is $119,000, while, at the end of 2021, we can find that it has increased to $134,900.

Although both total assets and total liabilities have increased, the increase in assets was greater than the increase in liabilities. In general, this is a sign of good financial health because it shows success in increasing its assets and earnings.

Net worth of individuals

Calculating the net value of individuals is the same concept as calculating the book value of a company. An individual's net wealth is simply the assets owned by that individual minus any liabilities that the person owes. It has the same calculations as that of companies.

Money

The main assets owned by an individual include checking and savings accounts, in addition to any investment portfolios (stocks, bonds, or real estate), and the market values of all the properties and vehicles the individual owns.

The main liabilities a person owes include different types of debt like credit card debt, mortgage debt, and unsecured loans such as student debt and other personal loans. Assets must be greater than liabilities in order to have a positive net wealth. 

If liabilities exceed the assets of an individual, the person is said to have negative net wealth. Your net wealth offers a glimpse of your current financial status. If you compute your current net worth, you will see the outcome of all of your past earnings and outgoing expenses.

Assigning precise numbers to all of your assets is one of the difficulties in determining your net worth. To prevent exaggerating your net worth, it's crucial to use cautious estimations when valuing specific assets, like the market value of your house.

There is some disagreement regarding whether or not houses should be counted as assets when determining net worth. Because they can be converted into cash in the case of a sale, some financial experts think that your home's market value should be regarded as an asset.

However, according to some authorities, even if the homeowner received money from the sale of the house, that money would still need to be used to buy or rent a new house. In essence, this means that the money received turns into a new liability to buy new real estate.

M&A Modeling

Everything You Need To Master M&A Modeling

To Help You Thrive in the Most Prestigious Jobs on Wall Street.

Learn More

Researched and Authored by Vatche TchelderianLinkedIn

Reviewed and edited by James Fazeli-SinakiLinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: