Net worth is the value of all resources of monetary value a company or an individual owns, known as assets, minus the value of all its outstanding liabilities.
Knowing your net worth is important for several reasons:
- It is a simple metric used to determine the financial state of a business or a person.
- It gives you a reference point for measuring progress towards your short-term and long-term financial goals.
Your net worth is usually reported on a “net worth statement” or “balance sheet”, which is often prepared at the beginning and ending of the accounting period but can be done at any time.
The statement provides the assets of the business and their value, and the liabilities or financial claims against the business.
The formula for computing net worth is: Net Worth= Assets – Liabilities
Understanding Assets and Liabilities
An asset is a property that can be converted into cash in current and future periods for a business or an economic entity. Assets are usually divided into two categories: current and long-term.
- Current assets consist of cash and other assets that may be turned to cash within one year of the date on the balance sheet. Cash, inventory, supply and account receivable are examples of a business’ current assets.
- Long-term assets are typically permanent assets, whether tangible or non-tangible, that will benefit a company for more than 10 years. Examples of long-term assets are long-term investments, property, plant and many others.
Liabilities are claims on assets and they are often classified the same way assets are classified.
- Current liabilities are a company’s debts or obligations set to be paid during the upcoming accounting period. The main current liabilities are account payable, accrued expenses, and short-term debt.
- Long-term liabilities also called long term debts, are any debts that will take more than a year to be paid. These include but are not limited to long-term notes payable, deferred taxes and bond payables.
Keeping track of these items on your balance sheet will help you measure your business’ success and see how every transaction impacts the whole company.
When a net worth is positive, it means that the value of an entity’s assets exceeds its liabilities. This is essentially an indicator of good financial health. Meanwhile, a negative net worth translates to an increase of liabilities relative to assets. In other words, you owe more than you own.
