Net worth is the difference between the assets and liabilities of a person or business. The concept is defined somewhat differently, depending upon whether the term applies to a business or an individual. The definitions are:
- Net worth for a business. This is the total amount of all assets minus all liabilities, as stated in the balance sheet. The information in the balance sheet may be stated at the original price of the asset or liability, which may differ from the amount at which it could potentially be disposed of. The asset and liability components of net worth typically include:
- Assets: Cash
- Assets: Marketable securities
- Assets: Accounts receivable
- Assets: Inventory
- Assets: Prepaid expenses
- Assets: Fixed assets
- Liabilities: Accounts payable
- Liabilities: Accrued liabilities
- Liabilities: Debt
- Net worth for an individual. This is total assets minus total liabilities. The information may be compiled from a number of sources, and typically includes the following:
- Assets: Cash in the bank
- Assets: Personal investments
- Assets: Resale value of house
- Assets: Resale value of automobiles
- Assets: Resale value of furnishings and jewelry
- Liabilities: Credit card debt
- Liabilities: Mortgage debt
As an example of net worth, a business has $50,000 of cash, $200,000 of accounts receivable, and $400,000 of inventory, which gives it total assets of $650,000. The business also has $80,000 of accounts payable and a $350,000 loan, which gives it total liabilities of $430,000. Thus, its net worth is the difference between the assets and liabilities, which is $220,000.
It is also possible to have a negative net worth, which arises whenever liabilities exceed assets for either a business or an individual.
Net worth can be used to derive the value of a business, though other factors may be included in the derivation of the sale price of a company, such as the value of its brands and intellectual property. It is not a good measure of the liquidity of a business, since the assets that comprise the measure may be ones, such as inventory and fixed assets, that are difficult to liquidate.
A company can increase its net worth not only by the obvious method of earning a profit, but also by avoiding distributions to shareholders (such as dividends), since that reduces the cash balance, which is part of the assets in the net worth equation.