Net Worth: What It Is and How to Calculate It

What Is Net Worth?

Net worth is the value of assets an individual or corporation owns minus the liabilities they owe. It’s an important metric to gauge a company’s health, providing a useful snapshot of its current financial position.

The term “net worth” is used in the financial world to qualify certain individuals for particular investment strategies or financial products such as hedge funds, structured products, or other complex or alternative investments. Net worth is sometimes referred to as net wealth. It has also become a fixation of popular culture with lists ranking the people with the highest net worth as well as the net worth of various celebrities.

How to Calculate Net Worth

Net worth is calculated by subtracting all liabilities from all assets. An asset is anything owned that has monetary value. Liabilities are obligations that deplete resources. They include loans, accounts payable (AP), and mortgages.

Net worth can be described as either positive or negative. Positive net worth means that assets exceed liabilities. Negative net worth indicates that liabilities exceed assets. Positive and increasing net worth indicates good financial health. Decreasing net worth is cause for concern because it might signal a decrease in assets relative to liabilities.

The best way to improve net worth is to either reduce liabilities while assets stay constant or rise or increase assets while liabilities either stay constant or fall.

Net Worth in Business

Net worth is known as book value or shareholders’ equity in business. The balance sheet is also known as a net worth statement. The value of a company’s equity equals the difference between the value of total assets and total liabilities. The values on a company’s balance sheet highlight historical costs or book values rather than current market values.

Lenders scrutinize a business’s net worth to determine whether it’s financially healthy. A creditor might not be too confident in a company’s ability to repay its loans if total liabilities exceed total assets.

A consistently profitable company will register a rising net worth or book value provided that these earnings aren’t fully distributed to shareholders as dividends. A rising book value will often be accompanied by an increase in the value of a public company’s stock price.

Net Worth in Personal Finance

An individual’s net worth is the value that’s left after subtracting liabilities from assets. Liabilities include debts like mortgages, credit card balances, student loans, and car loans. Liabilities can also include obligations such as bills and taxes that must be paid.

An individual’s assets can include checking and savings account balances, the value of securities such as stocks or bonds, real property value, and the market value of an automobile. The net worth is whatever’s left after selling all assets and paying off personal debt.

People with substantial net worth are known as high-net-worth individuals (HNWIs). They form the prime market for wealth managers and investment counselors. Investors with net worths of at least $1 million either alone or together with their spouse and excluding their primary residences are “accredited investors” in the eyes of the U.S. Securities and Exchange Commission (SEC). They’re permitted to invest in unregistered securities offerings.

Example of Net Worth

Consider a couple with the following assets:

• Primary residence valued at $250,000
• An investment portfolio with a market value of $100,000
• Automobiles and other assets valued at $25,000

Liabilities include:

• An outstanding mortgage balance of $100,000
• A car loan of $10,000

The couple’s net worth would therefore be calculated like this:

[$250,000 + $100,000 + $25,000] - [$100,000 + $10,000] = $265,000

Assume that the couple's financial position changes five years later. The residence value is $225,000, investment portfolio is $120,000, savings total $20,000, and their automobile and other assets are valued at $15,000. Their mortgage loan balance is $80,000, and the car loan is $0 because it was paid off. Their net worth five years later would be:

[$225,000 + $120,000 + $20,000 + $15,000] - $80,000 = $300,000

The couple’s net worth has gone up by $35,000 despite the decrease in the value of their residence and car. These declines were more than offset by an increase in assets by adding the investment portfolio and savings as well as a drop in liabilities owed.

Negative Net Worth

A negative net worth results if total debt is more than total assets. Their net worth will be negative if the sum of an individual’s credit card bills, utility bills, outstanding mortgage payments, auto loan bills, and student loans is higher than the total value of their cash and investments.

Negative net worth is a sign that an individual or family needs to focus its energy on debt reduction. A tough budget, the use of debt reduction strategies such as the debt snowball or debt avalanche, and perhaps negotiation of some debts with creditors can sometimes help people climb out of a negative net worth hole and start building up their resources.

A negative net worth isn’t uncommon early in life. Student loans mean that even the most careful-with-money young people can start out owing more than they own. Family responsibilities or an unexpected illness can also push people into the red.

Filing for bankruptcy protection to eliminate some of the debt and prevent creditors from trying to collect on it might be the most appropriate solution when nothing else has worked. Some liabilities can’t be discharged, however. They include child support, alimony, taxes, and often student loans. And many types of bankruptcy will stay on an individual’s credit report for 10 years.

The Bottom Line

Net worth is a good way of understanding the true wealth of an individual or business. Looking only at someone’s assets can be misleading because this is often offset by some amount of debt and liabilities. Net worth can be increased by increasing assets while reducing debts and other liabilities.