When you read a profile of a successful firm or an individual, a parameter used to quantify their economic status is their net worth. Net worth is an effective indicator of the financial health of a person or an entity. It is the total value of assets owned by a party after subtracting their liabilities.
Let us understand the finer aspects of net worth and what it implies.
What is net worth?
Celebrities, entrepreneurs, companies, sectors, and countries are often ranked based on their net worth. It is a metric that determines how wealthy they are and is sometimes also referred to as net wealth. Some financial products require a person to have a minimum net worth to qualify for investment.
Net worth calculation
The net worth calculation for a person or an entity considers the total assets and liabilities. All entities that have financial worth are known as assets. This includes cash, deposits, property, precious metals, etc. Liabilities include loans, mortgages, accounts payable, or other obligations that must be paid for. The amount in liabilities is subtracted from the total assets to derive the net worth.
The resultant value can be positive or negative. A positive net worth points to a favourable financial position because assets are more than liabilities. A negative net worth indicates poor financial health because the person or entity under consideration owes more than they own.
Application of net worth
Net worth is calculated for businesses and personal finance.
In businesses, it shows the organisation’s economic value and is also known as book value or shareholder’s equity. Since the organisation’s balance sheet includes assets and liabilities, it is also termed a net worth statement. However, these values on the balance sheet are past values and not current market costs.
Financial institutions and lenders use net worth data to assess the company’s financial standing and determine if it would be wise to invest in it. A negative net worth indicates high-risk levels for the lender because the borrower may not be able to repay the dues.
When a company’s profits rise, its net worth will also increase. This will reflect in the stock price of the company.
In personal finance, debts or liabilities for individuals include credit card dues, mortgages, other loans, bills, and taxes. In contrast, assets include owned properties, bonds or stocks, automobiles, cash, bank account balances, and fixed deposits. The values used for personal net worth calculation are the current market values and debt costs.
Net worth example
Suppose an individual has the following assets and liabilities:
- A house worth Rs. 90,00,000
- An office worth Rs.1,00,00,000
- A car with a current market value of Rs.10,00,000
- Fixed deposits worth Rs. 5,00,000
- A mortgage balance of Rs. 25,00,000
- A student loan of Rs. 8,00,000
The net worth of the individual is calculated by subtracting liabilities from the assets:
Net worth = [Rs. 90,00,000 + Rs. 1,00,00,000 + Rs. 10,00,000 + Rs. 5,00,000] – [ Rs. 25,00,000 + Rs. 8,00,000] = Rs. 1,72,00,000
Since the liabilities are lower than the assets, they have a positive net worth and thus are in good financial health.
Conclusion
Net worth is an indicator of wealth for an individual or organisation. The trajectory of net worth depends on your lifestyle, goals, financial needs, and other factors. Negative net worth is typical at the beginning of one’s career. However, you can reduce your debts and increase your net worth with timely and intelligent investments. A good net worth helps organisations stay afloat during hard times and expand their business when required. In the case of personal finance, a good net worth makes way for a comfortable life and easy retirement.