What is Net Worth?
Net worth refers to the value of everything that you own and comprises both financial and non-financial assets. It primarily serves as an indicator of your financial health. Your net worth is the figure you obtain when you add up everything you own and subtract the debts you owe in the form of student loans, car loans, mortgages, credit card balances, and more.
Net worth can be estimated by subtracting all the liabilities owed from the assets. An asset is everything with a monetary value that you own whereas liabilities refer to obligations that result in depletion of resources.
Your net worth can either be positive or negative. A positive net worth implies that your assets exceed your liabilities while a negative value indicates that your liabilities exceed your assets. A positive and increasing net worth signifies good financial health whereas a negative net worth can be a cause of concern as it indicates a decrease in assets.
- Net worth indicates your financial and non-financial assets minus your liabilities.
- If your debts exceed your assets, then your net worth is considered to be negative.
- A consistent increase in the net worth indicates good financial health. It implies that your assets are growing at a rapid pace in comparison to your liabilities.
Importance of Net Worth:
When you check your net worth in a balance sheet, you gain an idea about where you stand financially. Reviewing your net worth statements over time will help you identify where you stand financially and how to achieve your goals. An assessment of your net worth statement will provide you encouragement and will ensure that you are heading in the right direction. It also serves as a wake-up call if you are not on the right track.
What does a negative Net Worth imply?
There is no need to panic if the net worth of a company or an individual is negative. It simply indicates that the person has a substantial amount of loan or debt to pay off. If your net worth is negative it simply means that you haven’t earned or invested enough money to overcome the weight of liabilities that you own. It could also be a result of over-borrowing. You need to chalk appropriate plans to offset the liabilities.
Each time you clear debt, your assets start increasing. You can increase your net worth by paying off your debts, investing money, and saving. If you own a home, then paying your mortgage can increase your net worth.
How to Calculate Net Worth?
For estimating your net worth, you need to gather and organize all the information about your finances. Having easy access to the information will help you accurately estimate your worth. You will require basic financial information about what you own and the debts you need to repay. Deducting your liabilities from the assets you hold will give you a clear picture of the health of your finances.
You can use the following formula for the net worth calculation.
Net Worth NW=Current Assets(CA) - Current Liabilities(CL)
Let us consider a few examples to understand how net worth is calculated. The formula can be applied for estimating the net worth of both businesses and the net worth of individuals.
Let us consider an entrepreneur Avinash who owns a home worth ₹4.5 crores and owes ₹45 lakhs as a home loan. He owns two cars worth ₹75 lakhs and has paid off his car loans. He has ₹ 2.5 lakhs in credit card balances and has ₹48 lakhs in his savings account and has investments worth ₹22 lakhs in mutual funds, gold, and others.
- Home: ₹4.5 crores
- Car: ₹75 lakhs
- Savings: ₹48 lakhs
- Investment = ₹22 lakhs
Current Assets CA= ₹4.5 crores+₹75 lakhs+₹48 lakhs+₹22 lakhs= ₹5.95 crores
- Credit card= ₹ 2.5 lakhs
- Home loan = ₹45 lakhs
Current DebtsCD= ₹2.5 lakhs + ₹45 lakhs= ₹47.5 lakhs
Avinash’s Net Worth = ₹5.95 crores - ₹47.5 lakhs = ₹5.475 crores
Let us consider an example of company ABC Ltd. This will give you a clear idea of what the net worth of a business means. ABC Ltd. holds ₹17 lakhs in cash, ₹19 lakhs in equipment, ₹9 lakhs in accounts receivable, and ₹45 lakhs in the property.
The total asset owned by the company is ₹90 lakhs. We need to now consider the liabilities that the company owes. The business has accounts payable ₹ 45 lakhs, equipment loans of ₹ 12 lakhs, and a loan on the industrial property of ₹ 21 lakhs. It further has borrowed 15 lakhs for the smooth running of operations that it needs to repay. The total amount of liabilities for the business equals ₹93 lakhs.
Net worth = ₹90 lakhs -₹93 = - ₹3 lakhs
A negative net worth of ₹ 3 lakhs indicates that for the company ABC Ltd, its liabilities exceed its assets. This clearly indicates the meaning of net worth in the balance sheet and how important it is for any business.
You now know what is meant by net worth. It is a crucial parameter to evaluate the financial health of a company or an individual. It is a grand total of all the assets owned by a business or individual minus the liabilities. Calculating net worth and its interpretation help in understanding where a business actually stands. It further helps businesses in making crucial financial decisions.
It is essential to be conservative with the estimates especially when it comes to assessing home and vehicle values. Inflating the value of assets may look good on paper. However, it will indicate an inaccurate picture of the net worth. To boost your net worth, you need to keep liquid savings in a high yield account which in turn will help you grow your assets faster. You need to prioritize debt repayments to boost your assets and can also turn to refinance options if you have a negative net worth. Reduce your expenses and review your budget to allocate more money for debt repayment or for savings.
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