Net worth, in a simplified way, is the set of financial resources that one possesses, after discounting the debts acquired. This very general definition applies to companies as well as individuals, families, institutions and even states.
However, in practice, the term is mainly used to refer to a company’s financial situation, as we will see below.
The importance of knowing your net worth is maximum. Its result is key for making future decisions. A positive net worth ensures the continuity of the project, while a negative one warns of its unviability unless corrective measures are included.
In this article we analyze the concept of net worth focused on companies, the advantages of knowing it, how it is calculated, and some examples.
What is the net worth of a company?
The net worth of a company is an accounting concept that allows it to measure its value and, in this way, quickly know the situation of its finances and its solidity. It is a fundamental concept that offers a clear vision of said financial situation, which is beneficial information for investors, shareholders, as well as the company’s managers themselves.
In short, it is the result of analyzing all the resources available to a company, as well as its obligations and debts. The universal definition of net worth is the accounting difference between a company’s assets and liabilities.
And at this point, the net worth must be positive, which would indicate that the company has maintained its own resources and income, without having to resort to external financings, such as investors, loans or credit accounts. On the contrary, a net worth less than zero, negative, would mean that the company is being financed with external capital, and cannot maintain itself.
As mentioned, assets and liabilities are the accounting terms that determine net worth. Thus, assets are understood to be the set of resources, goods, rights and values that a company has. They are classified into two types: current assets and non-current assets. The first, also called current or liquid assets, are those that the company expects to consume or convert into cash in the short term, generally during a fiscal year. Non-current ones, on the other hand, are those that remain in the company’s possession for more than a year.
As for liabilities, it is an accounting term that refers to all of the debts and financial obligations that a company has. In more colloquial terms, it would be the money that the company owes to third parties. As in the case of assets, we find current liabilities, debts that mature in less than one year, and non-current liabilities, whose maturity is greater than one year.
Some advantages of knowing the net worth of a company
- Helps investors in decision-making. Before investing, they analyze whether said investment is attractive, and net worth is the best indicator of this.
- It favours decision-making when analyzing the company’s economic planning and can, where appropriate, help correct possible deviations.
- It serves as a guarantee for creditors, since it indicates the situation of the company and, therefore, contributes to assessing the risk when granting a loan.
You can use the net worth, if it is positive, to finance your own business, study expansion projects or improve your infrastructure.
How net worth is calculated
To calculate the net worth it is necessary to know, in turn, the assets and liabilities of the company, since, as we have indicated, the net worth is the difference between the other two concepts: that is, the result of subtracting the liabilities to the company’s assets. By applying this formula, the net result can be positive or negative. If it is positive, it indicates that the company is in a good financial situation, since it has more resources than debts. On the contrary, if the net worth is negative, it indicates that the company owes more than it has and, therefore, it must be alert.
Does having a negative net worth mean that a company is bankrupt? With the accounting manual in hand, yes, one would go into technical bankruptcy. However, if a year results in a negative net worth balance, it is normal that it could be something temporary, due to some investment or specific decline in the business. To do this, we must wait or analyze the results of the following exercises to see if it is a constant or just a critical situation experienced that year.
Formula to calculate net worth
The net worth of a company is calculated with this simple formula:
Net worth: Assets – Liabilities
To apply this formula it is necessary to know exactly what elements make up both the assets and the liabilities.
Some more common types of assets would be:
- Property
- Machinery and computer equipment
- Vehicles
- Collection rights for services provided to third parties or sale of products to their clients
- Investments or securities with medium or long-term benefits
The most common liabilities are:
- Bank loans
- Workers’ salaries
- Debts with suppliers
- Customer deposits
- Taxes
Examples of net worth
For very simplified examples to visualize net worth, we can indicate the following:
- An aesthetic clinic has machinery valued at 150,000 dollars. To acquire it, he requested a loan from the bank of 100,000 dollars. Applying the formula, the net worth of this company would be 50,000 dollars.
- A courier company has a fleet of 5 vans, jointly valued at 210,000 dollars. He has no debts or obligations, so, in this case, his net worth matches his assets: 210,000 dollars.
- A supermarket records a real estate and merchandise asset of 175,000 dollars. However, it has a debt incurred in its liabilities of 195,000 dollars. In this case, the net worth shows a negative result of 20,000 dollars.
