Net Worth: What It Is and How to Calculate It? A Complete Guide
Net worth is the personal wealth an individual has accumulated, without considering their debt. Similarly, the net worth of a company is a reflection of its assets without liabilities. In the context of both, they signify financial health. Read this article to learn more about net worth, how it’s calculated and the importance of net worth.
Aliko Dangote just got richer by $1.5 billion in November 2022. He also bagged the NECAs lifetime achievement award. He currently holds a net worth of $19.1 billion. Additionally, there is a lot of buzz about Elon Musk and his net worth of ~$185 billion considering his ownership in SpaceX and Tesla.
After reading all the news about Dangote and Musk, you must wonder what net worth is and how to calculate net worth. Net worth has become a fascinating topic of discussion all around pop culture.
Read this article to understand what net worth means for businesses and individuals alike.
What is net worth?
Net worth is the value of an individual or company’s assets, minus the liabilities or debt they owe. This is an essential metric to understand the company’s financial performance or an individual's financial health. Net worth is also often labelled as net wealth.
Net worth is a quantitative measure of an entity that provides a picture of financial health and performance. Individuals who have a sizeable amount of worth are known as high-net-worth individuals. Public figures and individuals listed on The Forbes 400 are HNWI or high-net-worth individuals.
Net worth is important as it gives you an impression of your financial health. If your assets are more than your liabilities, your financial health is in good shape. If your liabilities are more than your assets, you need to work on debt repayments. Net worth relies on investments and possessions over one’s income itself. You may think that an individual with a high salary has a higher net worth by default when compared to an individual who earns a modest amount. If the individual with a high salary spends more and does not invest smartly, they could possibly have a net worth lower than the individual who earns modestly.
How do you calculate net worth?
To sum up and explain net worth in a simple equation,
Net Worth = Assets - Liabilities
If an individual or company owns assets that are more than their liabilities, it indicates a positive net worth. Positive net worth is indicative of healthy financials. When the liabilities exceed the assets, it signifies a negative net worth. A negative net worth signifies that the individual or company is unable to pay off debt and settle liabilities.
Net worth is not limited to individuals or organizations. Net worth is applicable to different groups, governments or even countries.
Calculating net worth seems easy on the surface but can become complicated once one considers the nuances of how assets and liabilities are classified.
When calculating assets in the net worth equation, one must consider all assets that include a tangible value. Individuals can include material possessions such as their cars, art, houses, bank accounts and investments in the assets section of net worth. Typically, personal belongings such as furniture are not considered assets as these belongings are not sold in the case of bankruptcy.
When calculating liabilities in the net worth equation, debt and obligations that require repayments are considered. This can include student and house loans, mortgages and more. Calculating liabilities also considers outstanding repayments and not repayments that will be due in the future. In most cases, house rent is also excluded from liabilities and net worth calculations.
As we read earlier, the net asset amount after subtracting liabilities gives rise to net worth. Calculating net worth is a result of making a list of assets and liabilities and deducting the liabilities from the assets. This can be assessed on an annual basis to understand the financial health of an individual or an organisation.
Net Worth in Business
When formulating net worth for a business, the same equation stands.
Net Worth = Assets - Liabilities
In the context of a business or organisation, an asset is an owned property with monetary value. Liabilities are responsibilities that eat into the value of assets.
When one looks at assets in a company, one would consider those that include tangible value. Material possessions such as industrial equipment and transportation. Similarly, intangible assets such as patents are considered net assets with net worth.
Net worth is either positive or negative in a company or organization. If net worth is positive, assets are more in value when compared to liabilities. This indicates good financial health and positive net worth. On the other hand, if liabilities are more than assets, it is indicative of decreasing or negative net worth.
To improve the net worth and make the value positive, an organization must ensure that its assets are on the rise with debt or liabilities being reduced gradually.
When discussing businesses, net worth is known as shareholders' equity. The balance sheet at the end of the financial year is known as the net worth statement of the organization. The values on a company's balance sheet would always highlight book values that are not based on the market value in the current situation.
Whenever a lender or creditor tries to assess if a business is financially sound, they look at the organisation's net worth. If the total liabilities are more than the total assets, the lender or creditor would question their confidence before letting out an investment.
This is indicative of the fact that loans may not be paid on time considering the existing load of liabilities on the company's balance sheet.
If the company or organisation is profitable year-on-year, it will register an increasing net worth provided the profits are not entirely given out to shareholders as dividends. Similarly, a public company will see an increase in stock price as its net worth increases positively.
Net Worth in Personal Finance
One can calculate an individual's net worth by subtracting liabilities from assets. Liabilities for an individual would include credit card debt, education loans and mortgages.
Additionally, obligations that cannot be avoided such as bills and taxes can also be considered in this definition.
On the other hand, assets would include money in a savings account, investments in different assets such as stocks & mutual funds, real estate, and the current price of a car or bike. Whatever may be left after paying off debt and selling assets determine's one's personal net worth.
The value of personal net worth functions on current market prices and not on the book value when compared to businesses and organizations.
High-net-worth individuals are people with substantial net worth. They function as investment counsellors and wealth managers, often holding social influence. Accredited investors are those who have at least $1 million without the consideration of their property.
Example of Net Worth
Consider a pair with these assets:
- 2 BHK residence at NGN 350,000,000
- Investments valued at NGN 300,000,000
- Other assets valued at NGN 100,000,000
At the same time, they also hold liabilities that include:
- Outstanding mortgage balance of NGN 100,000,000
- An education loan of NGN 30,00,000
The pair's net worth would look something like this:
- [NGN 350,000,000 + NGN 300,000,000 + NGN 100,000,00] - [NGN 100,000,000 + NGN 30,00,000] = NGN 377,000,000
Let's assume that in five years, the pair's financials change. It looks something like this:
Assets in hand
- 2 BHK residence at NGN 400,000,000
- Investments valued at NGN 500,000,000
- Other assets valued at NGN 150,000,000
At the same time, they also hold liabilities that include:
- Outstanding mortgage balance of NGN 30,000,000
- An education loan of NGN 0, as the loan was paid off
The new net worth would look like this:
- [NGN 400,000,000 + NGN 500,000,000 + NGN 150,000,000] - [NGN 30,000,000] = NGN 10,20,000,000
The net worth has gone up as the liabilities and loans were offset while the value of the assets increased.
Negative Net Worth
An individual or business encounters a negative net worth when its liabilities are more than its assets. Or when their debt surpasses their assets. If an individual's credit card bills, education loans and more surpass the value of their total investments, net worth would still be negative.
A negative net worth is a sign that the individual must focus on reducing debt. Using a sound budget, reducing debt without the snowballing effect and even negotiating with lenders can bring individuals and families out of debt traps. Once an individual climbs out of this, they can build up their net worth in a positive direction.
When starting as a young individual who is earning, a negative net worth would not be uncommon. Education loans and other expenses for young people can lead them to owe money. Unforeseen circumstances like medical emergencies can also push individuals to hold a negative net worth.
Net worth gives one an insight into understanding the true or real wealth of an individual or business. If one decides only to look at the assets and not the liabilities, it can paint an unclear picture. Certain liabilities can be offset by assets. One's net worth increases when assets amount to more than liabilities.
What Is Considered a Good Net Worth?
Good net worth is a subjective decision. This amount would vary for every individual based on their circumstances, situations and lifestyle. One must strive to bring their net worth to the positive side, as much as possible.
How Do I Calculate My Net Worth?
To calculate your personal net worth, subtract your liabilities from your assets. Your assets would include investments, cash deposits and any other equity you hold. Additionally, liabilities include student loans and debt. You can check net worth calculators online to get a better insight into the areas you should improve in.
How Much Should I Have Saved?
Your savings depend on your age, income potential, career choice, lifestyle and personal circumstances. As a best practice, saving at least three times your annual salary by the age of 40 across your retirement accounts is a suitable option.