Net worth is the value of all the non-financial and financial assets owned by an institutional unit or sector minus the value of all its outstanding liabilities. But to put it simply, net worth is basically the amount by which assets exceed liabilities. It is a key for individuals and businesses to measure how much they are worth. Net worth can apply to companies, individuals, governments or economic sectors such as the sector of financial corporations or to entire countries.
A company’s net worth is like a financial summary that shows the dollar value of what the company owns and what they owe. If a company’s assets exceed their liabilities, then they have a positive net worth, and on the other hand, if their liabilities are greater than their assets, then they have a negative net worth.
However, even a company with a high net worth may have financial difficulties. Having many assets with low liquidity (inability to immediately convert assets to cash) may mean not having adequate cash available to pay current expenses if income suddenly decreases.
Net worth is calculated thus; Assets – Liabilities = Net worth
The formula used to calculate the net worth of a company is the same as the formula that is used to calculate the net worth of an individual. The assets of the company, or items that it owns or holds the title to, minus its liabilities, equal the owner’s equity.
The net worth of a company is only valid at a specific date because company accounts usually fluctuate because of the constant financial exchange. You should know that this simple calculation applies whether your business is the smallest sole proprietorship or a large publicly traded corporation.
When computing corporate net worth, typical assets include cash, marketable securities, accounts receivable, inventory, prepaid expenses and fixed assets. Liabilities include items such as accounts payable, accrued liabilities and debt.
Net worth is a performance indicator that shows the value of your business’s property after liabilities are paid. Once you settle all business debts, the net worth includes what is left over. You can use net worth to determine your financial health, secure funding, or sell the business and much more.
How to calculate a company’s net worth
It has been said that a company’s net worth equals its total assets minus its total liabilities. Knowing a company’s net worth can give investors a better understanding of a company’s financial strength, including how much money a company would have after liquidating all assets and paying off all debts. Net worth is also known as stockholder’s equity or shareholder’s equity.
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Find out Total Assets
The first step in determining the net worth of a company is identifying its total assets. You can do this by referring to the company’s most recent balance sheet where assets are listed first. Assets are measurable resources that will provide future economic value to the company. Current assets such as cash, cash equivalents, prepaid expenses, inventory, supplies, investments and accounts receivable are assets that can be redeemed within a year. In addition, businesses typically hold long-term and fixed assets like equipment, buildings and land. Assets can also be intangible items like patents, trademarks and licenses.
Consider Asset Valuation
After identifying assets, ensure that the assets are valued using an appropriate valuation method. Generally accepted accounting principles require a business to value different assets using different methods. Most assets on the balance sheet are generally valued at the price the business paid. However, there are exceptions and nuances. For example, inventory may be valued at a lower of cost or the fair market value of the assets. Assets like property and equipment are valued at cost less accumulated depreciation, while land is not depreciated.
Determine Total Liabilities
After identifying and determining total assets and their valuation, you now have to determine the liabilities of the company. Company liabilities are obligations that a business owes to outside parties like vendors, creditors, employees, clients or the government. Just as with assets, liabilities can be either short-term or long-term. Short-term, or current liabilities are amounts that must be paid within a year or less. Accounts payable, sales tax payable, interest expense, unearned revenue and wages payable to employees are typically short-term liabilities. Retirement benefits for employees, long-term notes payable and bonds payable are usually due in more than a year and are categorized as long-term liabilities.
Subtract the assets and liabilities
Subtract total liabilities from total assets. The resulting amount is the net worth (or net assets) of the company at the specific date or point in time that you make the calculation. If one of the company’s assets is an investment portfolio with many common stocks, the net worth of the business could change only hours after calculation.
Let us take for instance, XYZ business, which is a typical small business has $50,000 in cash, $600,000 in equipment, $30,000 in accounts receivable and $620,000 in land. All these are its assets.
$600,000 + $30,000 + $620,000 = $1,300,000
The total amount of all these assets equals $1,300,000.
The business on the other hand has the following liabilities; accounts payable $100,000, equipment loans of $550,000 and a commercial mortgage on a warehouse for $600,000.
$100,000 + $550,000 + $600,000 = 1,250,000
The total amount of liabilities for this business equals $1,250,000.
Subtract the total liabilities from the total assets to get the net worth of the business. In this example, this small business has $1,300,000 in assets and $1,250,000 in liabilities.
$1,300,000 – $1,250, 000 = $50,000
Subtracting $1,300,000 from $1,250, 000 equals $50,000. This therefore means that the net worth of this business is $50,000
Benefits of calculating a company’s net worth
Get a complete view of business finances: Net worth shows a company’s financial health because it accounts for both assets and liabilities. Net profit alone will not give an accurate picture of financial health. By factoring in expenses, taxes, and debts, you can compare what you own to what you owe.
Track your progress: By making records, you can see if your net worth changes over time. If your net worth increases, it’s a sign that your business is healthy and growing. If your net worth shrinks, your business could be in trouble, and changes need to be made.
Gain perspective on your debt: Net worth shows how much debt you’ve incurred and how much money you have to cover the debts. Even if you have a lot of liabilities, your business could still be healthy if your assets are larger than the debts. On the other hand, if your assets are smaller than liabilities, you may need to improve your business debt management skills.
Secure outside funding: Since net worth is found with cumulative reporting, it gives a picture of your business’s stability. To apply for a small business loan, you need to report your net worth. Lenders want to know your financial strength. The stronger your finances, the less risky it is to lend to you.
Limitations of Net Worth
Net worth helps an interested party understand how financially sound a business is. Higher net worth means a business has more resources to invest in new growth opportunities or to pay for unexpected expenses. However, there are limitations to the usefulness of net worth calculations. Because most assets are valued at cost, net worth may not provide an accurate representation of the fair market value of the assets. Net worth also doesn’t consider the future potential earning power of the business. Because of these limitations, investors often also consider financial ratios and business valuations when evaluating a company.