Net Worth: What It Is and How to Calculate It

What Is Net Worth?

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

Sometimes called net wealth, one's 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 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 assets. An asset is anything owned that has monetary value, while liabilities are obligations that deplete resources, such as loans, accounts payable (AP), and mortgages.

Net worth can be described as either positive or negative, with the former meaning that assets exceed liabilities and the latter that liabilities exceed assets. Positive and increasing net worth indicates good financial health. Decreasing net worth, on the other hand, is cause for concern as 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 can be applied to individuals, companies, sectors, and even countries.

Net Worth in Business

In business, net worth is also known as book value or shareholders' equity. 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. Note that the values on a company's balance sheet highlight historical costs or book values, not current market values.

Lenders scrutinize a business's net worth to determine if it is financially healthy. If total liabilities exceed total assets, a creditor may not be too confident in a company's ability to repay its loans.

A consistently profitable company will register a rising net worth or book value as long as these earnings are not fully distributed to shareholders as dividends. For a public company, a rising book value will often be accompanied by an increase in the value of its stock price.

Net Worth in Personal Finance

An individual's net worth is simply the value that is left after subtracting liabilities from assets.

Examples of liabilities include debts like mortgages, credit card balances, student loans, and car loans. Liabilities can also include obligations that must be paid such as bills and taxes.

An individual's assets, meanwhile, 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. Whatever is left after selling all assets and paying off personal debt is the net worth.

People with substantial net worth are known as high net worth individuals (HNWI) and form the prime market for wealth managers and investment counselors. Investors with a net worth, excluding their primary residence, of at least $1 million—either alone or together with their spouse—are "accredited investors" in the eyes of the Securities and Exchange Commission (SEC), and, therefore, 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 as:

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

Assume that five years later, the couple's financial position changes: the residence value is $225,000, investment portfolio $120,000, savings $20,000, automobile and other assets $15,000; mortgage loan balance $80,000, and car loan $0 because it was paid off. Based on these new figures, the 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. As we can see above, these declines were more than offset by increases in other assets, in this case, 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. For instance, 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, their net worth will be negative.

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.

Early in life, a negative net worth is not uncommon—student loans mean 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.

When nothing else has worked, 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; however, some liabilities—such as child support, alimony, taxes, and often student loans—cannot be discharged. It’s also worth bearing in mind that bankruptcy will stay on an individual's credit report for many years.

The Bottom Line

Net worth is a good way of understanding the true wealth of an individual or business. Looking only at one's assets can be misleading since this is often offset by some amount of liabilities, such as debt. One's net worth can be increased, therefore, by increasing assets while reducing debts and other liabilities.