Net worth (sometimes called net or wealth) is the total assets minus total outside liabilities of an individual or a company. We use Net worth when talking about the value of a company or in personal finance for an individual’s net economic position.
Put another way, net worth is any asset owned minus any debt owed. This means that Net worth can be a negative number if one’s debt owed is greater than the value of the assets owned.
Net worth in business
Generally, Net worth in business is based on the value of all assets and liabilities at the carrying value; Which is the value as expressed on the financial statements. To the extent items on the balance sheet do not express their true (market) value; the net worth will also be inaccurate. On reading the balance sheet, if the accumulated losses exceed the shareholder’s equity, it’s a negative value for net worth.
For a company, this is called shareholders’ preference and may be referred to as book value. We state net worth as at a particular time in a year. Net worth in this formulation is not an expression of the market value of the firm; the firm may be worth more (or less) if you sell it as a going concern.
Net worth for individuals
For individuals net worth or wealth refers to an individual’s net economic position; similarly, it uses the value of all assets (long term assets) minus the value of all liabilities
In relation to a deceased individual we can use net worth for the value of an estate when in probate.
How to calculate and monitor your net worth
Periodically monitoring your net worth is a good way to get a quick snapshot as to whether or not you are improving your financial situation over time.
Your net worth is simply what you own minus what you owe.
What you own are your assets and what you owe are your liabilities.
We’ll start with a simple example before we dig a Little Deeper:
Let’s suppose Jeremy wants to calculate his net worth. He’ll start by listing all his assets:
He has a $300,000 home, a $20,000 car, $5,000 in a checking account, and $15,000 in his tax-free savings account. Adding up all his assets, what he owns, comes to $340,000.
Next, he’ll list all his liabilities:
He has a $200,000 balance remaining on his mortgage, he’s car loan has a balance of $15,000, he carries $3,000 on his credit cards from month to month, and he has a student loan of $27,000. Adding up all his liabilities, what he owes, comes to $245,000
When we take what he owns $340,000 and subtract what he owes $245,000 Jeremy’s net worth is $95,000
Now, that we know the basics of calculating net worth let’s think about how we can use it.
Perhaps once per year, Jeremy could recalculate his net worth to see if his financial situation is improving or not.
The following year his house has appreciated to $310,000 but his car is depreciated to $17,500. He still has $5,000 in his checking account but he tapped into his TFSA and it’s now empty. The new Total for his assets is $332,500
His mortgage balance is now $190,000. The car loan is now $12,500, and he paid off his credit card by opening up a line of credit. He also used his line of credit to pay for a vacation and a new roof for the house. So the balance here is $20,000, his student loan is now $24,000, and his liabilities now total $246,500
His new net worth is $86,000 which is $9,000 worse than last year.
Generally speaking, you want to focus on increasing your net worth during your working career by either increasing the value of the assets side or decreasing the value of the liabilities side.
Here are a few more things to keep in mind:
- Large assets May fluctuate in value and result in a decrease in net worth even though you’re doing all the right things with managing your money.
For example, the value of Jeremy’s house may decrease by $20,000 in a year. The same could happen with a long-term investment portfolio which can go up and down in value over the short-term.
Registered Retirement Savings Plans (RRSP) have a future tax liability attached to them.
When you take money out of your RRSP it’s treated as income and subject to income tax. That means if your RRSP is worth $200,000 you likely won’t get to spend all of it.
Some people choose to estimate the future tax liability on the liability side of the net worth calculation while others ignore it.
It’s possible to have a big house and fancy cars but have a low net worth; because you owe a lot of money too.
Similarly it’s possible to have a modest house and unremarkable cars and have a high net-worth.
It’s impossible to judge this book by its cover but knowing how to calculate and monitor your own net worth is a basic tool of personal finance that you should understand.
Long term assets are non-liquid. Meaning your company will possess them for greater than one year, and it will take some time to sell them off if necessary. This includes real estate owned, including land and buildings, leasehold improvements to rented space, and vehicles. It can also include the accumulated depreciation, the yearly decrease in value, on these long-term assets. It also includes the equipment you will use longer than a year, such as cranes, office equipment, or computer systems.
Liquid assets are resources that are easily converted into other assets or used to pay for goods, services, or liabilities.
When we’re thinking about liquid assets we’re thinking about the idea of paying for goods and services or liabilities with those assets and how easy it would be to do that.
How easily can we convert the asset that we have to something that can be expanded for goods or services or pay off a liability?
Often times it’s easy to think about that in terms of the relationship to cash. How close to cash is a particular asset? Because cash is generally the most liquid asset, the thing that we can use most readily to pay for goods and services or to pay off liabilities
For example, we can think of these liquid assets in terms of degrees of liquidity; Cash being the most liquid asset.
Other types of assets have other degrees of liquidity like accounts receivable as also usually being quite liquid. Meaning we can get cash in a relatively short period of time by selling these assets. Therefore the fact that we can use them or should use them in a short period of time to buy goods and services or pay off liabilities would make accounts receivables relatively liquid as an asset.
If we compare that to property plant and Equipment something like a forklift, a building, or land then we think about these as less liquid meaning that we can’t really use the forklift to pay off a liability or to pay for goods and services.
You may be thinking that you could get a loan against it or you could sell those items but that takes a bit more time. That’s not as easily doable as having cash.
So liquidity has to do with usage; And notice there’s always going to be that trade-off in terms of the liquid assets being something that we can spend really easily and the less liquid assets being something that we can’t generally just spend in order to buy goods and services or pay off liabilities. however, being things that are very necessary for the business as well and we have to find that balance between the liquidity of our assets that we have on hand.
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