To gauge the value of a business or an individual, it is critical to understand how to calculate net worth. A calculation which involves all the assets and liabilities of an entity, this value is relied upon to measure how valuable an entity is. This information is also utilized to determine the amount of assets an entity has compared to its liabilities, which helps business executives make important forward-facing financial decisions.
For those wondering “What is Net Worth?” or “Why is Net Worth Important to Me?”, know that this number is an important calculation for individuals just as much as for businesses. For determining retirement or financial aid eligibility, a statement disclosing an individual’s worth is often required. This information helps individuals know whether they can afford to take on additional loans, retire from their occupation, and can assists with other important financial decisions.
For investors in businesses, this calculation is important to determine the value of a business. Investors want to make sure the judgments they make with their money are sound and true. Knowing the worth of a business helps investors make sound investment choices, as they can avoid investing in a business heavily overburdened with liabilities.
This article will illustrate the net worth formula, how to calculate net worth step by step, and provide further examples on how net worth can be utilized in various scenarios.
Definition
The definition of net worth is the total liabilities subtracted from the total assets of an entity. Total liabilities include loans, debts, mortgages, credit card payments, accounts payable, salaries payable, taxes, and other liabilities commonly found on an entity’s financial statements. Total assets include tangible assets like capital including land or machinery and intangible assets like intellectual property.
This amount can also be expressed as ‘net value.’
What is Net Worth
Formula
Net worth is calculated by subtracting an entity’s total liabilities from their total assets. Total liabilities include all liabilities of an entity. Total assets include all assets of an entity. When solving for worth, no assets or liabilities are excluded from this calculation.
Where:
NW = Net Worth
The formula can also be expressed in terms of the tangible and intangible assets. Total assets include both tangible and intangible assets. Tangible assets are capital like land, machinery, or equipment. Intangible assets are assets which are not physical or are intellectual property, including goodwill, trademarks, patents, or copyrights. *
*If a company is trying to determine its worth in terms of only tangible assets, the intangible assets of a company can be removed from the formula. This is known as ‘Tangible Net Worth.’
How to Calculate Net Worth
Calculation Step by Step
- Determine total assets by adding all tangible and intangible assets.
- Determine total liabilities by adding all liabilities.
- Subtract the total liabilities from the total assets.
Following these steps will yield the net worth expressed in terms of currency like dollars, euros, or British pounds. This value represents the overall value of an entity in terms of its assets compared to its liabilities.
If the amount of an entity’s total liabilities is greater than its total assets, then the net worth of an entity will be a negative value. Having a negative worth can be common for individuals who have several liabilities like loans, debts, or a mortgage.
Example
A manufacturing company needs to determine its total value as of the second quarter of 2021.
Based on their entire business, the manufacturing company calculated the following values for their tangible and intangible assets:
Cash: $300,000
Investments: $1,000,000
Property: $2,000,000
Equipment: $500,000
Intellectual property: $1,000,000
The manufacturing company also calculated the following values for their total liabilities:
Property loans: $1,000,000
Other loans: $500,000
Accounts payable: $500,000
Salaries payable: $400,000
First, the manufacturing company will calculate all of their total assets:
Total Assets = Tangible Assets + Intangible Assets
Total Assets = (Cash + Investments + Property + Equipment) + Intellectual Property
Total Assets = ($300,000 + $1,000,000 + $2,000,000 + $500,000) + $1,000,000
Total Assets = $4,800,000
Next, the manufacturing company will calculate all of their total liabilities:
Total Liabilities = Property loans + Other loans + Accounts payable + Salaries payable
Total Liabilities = $1,000,000 + $500,000 + $500,000 + $400,000
Total Liabilities = $2,400,000
Finally, the manufacturing company will subtract their total liabilities from their total assets to determine the net worth of their business as of the second quarter of 2021:
NW = Total Assets – Total Liabilities
NW = $4,800,000 – $2,400,000
Net Worth = $2,400,000
Here we can see that the net worth of the manufacturing company is a positive value of $2,400,000. This indicates the total assets of the business outweigh their total liabilities, meaning the company is not overburdened with debt or other liabilities.
This information can help the company determine whether or not to take on additional loans, spending, or other purchases.
Tips for Calculating
Tip Number 1:
The net worth formula can be used to determine worth based on only tangible or only intangible assets. If an entity wants to know its value based only on the tangible assets in its possession, intangible assets can be removed from the equation. Alternatively, if an entity specializes in intellectual property, or has valuable patents or trademarks, tangible assets can be dropped from the equation to determine worth based solely on intangible assets.
Tip Number 2:
Net worth can be either a positive or negative value based on the value of assets or liabilities a company has. If an entity has more liabilities than assets, their worth will be negative. A common example of entities with negative worth are students, who often have little assets (like property, investments, or cash), but often have substantial liabilities in the form of student loans or credit card payments.
Tip Number 3:
Pricing both assets and liabilities accurately is critical to calculating the real net worth of an entity. While amounts like loans or cash on-hand are simpler to determine, deriving some values like estimates on equipment or the value of land can be more difficult. Intangible assets specifically are hard to assign accurate values to. For entities with intangible assets, ensure the value of these assets are calculated accurately, as they can easily skew an entity’s real worth – creating misleading information.
