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
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