Net worth is called a cost of assets that an individual or an enterprise possesses, subtracting their liabilities. It's a significant determinant in the financial soundness of the company. Net worth is presented in the form of a snapshot with the most important indicators.
Essence of Net Worth
A calculation of net worth takes place by deducting all obligations from assets. Notably, the asset means all tangible and intangible property of the enterprise. Obligations, in turn, present liabilities, which drain the company's resources, including accounts payable, credits on real estate, as well as loans.
Net worth may be defined as positive or negative. The first case contemplates assets surpassing obligations, while the second intends the opposite situation. Positive net worth also points to the decent financial standing of the enterprise. Alternatively, reduction of net worth provokes concern because it can be a sign of cutting assets in regards to liabilities.
The best practice to stimulate net worth is minimizing obligations or maximizing assets. In the first instance, assets are supposed to be permanent or growing. In the latter case, liabilities are expected to remain the same or to reduce.
Types of Net Worth
The division of net worth can be carried out according to its application field:
- Net worth of private entities. A net worth of respective individuals is calculated by deducting obligations from assets. Notably, obligations are also called debts, and the term contemplates a credit card balance, student loans, mortgages, as well as auto loans. By contrast, assets presuppose value of movables and immovables. All that remains after redemption of individual liabilities and asset divestitures is known as net worth. Persons with a significant net worth constitute a primary market for administrators of funds and financial advisors.
- Net worth in the business community. In money-making endeavors, net worth has an alternate name as balance sheet value, or stockholder’s equity. Equity cost of an enterprise's capital amounts to the difference between the cost of total assets and the joint liabilities. Take into account the fact that all the data in a balance sheet reflects the book value, but not the current one. At the same time, moneylenders study extensively the net worth of the enterprise to estimate its financial standing. In case total obligations surpass the number of assets, a creditor may doubt the firm’s capacity to settle up the debts.
- Net worth on a government level. A state’s net worth is considered an indicator of its financial stability. Some governmental authorities apply accrual accounting systems for granting a clear image of their operating expenses. Others prefer cash accounting with the view of envisioning prospective spendings.
Net Worth in real life
A net worth formula totals to a differential between assets and obligations. One must bear in mind that there exists two points towards the net worth:
- In case a net worth is greater than zero, the enterprise is able to settle payment obligations, and demonstrates welfare gains.
- If a net worth is lower than zero, the firm can’t satisfy the debts, and possesses adverse financial growth.
A case in point may be the enterprise N. Let’s consider the firm’s assets that include:
- A predominant residence at the cost of $300,000.
- An investment portfolio priced at $50,000.
- Vehicles and other assets totaling to $18,000.
While obligations of the company comprise:
- A property loan of $40,000.
- An education loan worth $6,000.
Calculating the net worth contemplates adding all the assets, mentioned above. Then it presupposes summing up every liability the enterprise owns. As a result, net worth is counted by deducting the second figure from the first one.
Negative Net Worth
An adverse net worth emerges, when a joint debt surpasses a total assets. The example is the following: the amount on credit cards, unredeemed mortgages, utility bills, as well as car and student loans exceeds the assets volume, which include overall price of cash and funds placement.
A negative net worth indicates the necessity of a private entity or a household to concentrate on debt relief. Thus, the following strategies can be applied, in order to start the downgrading of liabilities:
- Fixed expenditures.
- Debt avalanche.
- Conversations with moneylenders.
In case the aforesaid strategies aren’t working, a bankruptcy protection filing is the best way to cut the obligations. A point to keep in mind is a need to reveal the bankrupt status in the credit report for a long period of time.
Positive Net Worth
People have their own understanding of a favorable net worth. The indicator depends on a situation in life, living habits, along with financial requirements of a particular individual.
In reality, a positive net worth points to the assets outweighing the liabilities. It means that a person is on a way of wealth accumulation. The aim is to derive a benefit, so that in the times of economic instability, the individual has a potential to survive without much of a hassle.
There are certain steps to raise a capital:
- Invest more money. The committed funds will bring a greater fortune.
- Pay off a debt. The fewer the debt is, the less liabilities a person has.
- Generate revenue. An individual is able to find a side job, or ask for a promotion.