What is Net Worth and How Do We Calculate It?

The question that concerns individuals, companies, and on larger scales, countries, revolves around net worth. In any sound investment, we need to understand what net worth is and how to calculate it. As we see, the question is composed of two parts, and we will first address the initial part.

What is Net Worth?

In the simplest definition, net worth refers to the value of all the assets of an individual or a company, but with the important difference that we must subtract the liabilities of that individual or company from the total assets. By doing this, we arrive at the net worth of the assets. Net worth is not just a simple calculation method but a measure for assessing the financial health of a person or company. In fact, net worth provides a faithful picture of the financial status of the company at its current state.

Net Worth and the Risky World of Commerce

The answer we give to the question of what net worth is and how to calculate it shows us the value of a company or a business unit. Net worth is a quantitative concept with broad applications, covering a wide range of business practices. This range starts from an economic operator and extends to a country. In the world of commerce and financial sciences, net worth is seen as an honest and accurate value gauge. In the risky world of trade and economics, this concept holds vital importance.

Assets and the Question of What is Net Worth and How Do We Calculate It?

To get a more tangible understanding of the question of what net worth is and how to calculate it, it is better to define the fundamental concept of assets. In financial sciences, anything that has a monetary equivalent or monetary value is called an asset. Opposite to assets, there is another fundamental concept called liabilities. What are liabilities? Liabilities are any financial obligations that consume and decrease financial resources. If we want to point out examples of liabilities, we must mention loans, including mortgage loans and accounts payable (AP). When we subtract all liabilities from the total assets, we reach what is called net worth in financial sciences.

Positive Net Worth and Negative Net Worth

We are gradually getting a clearer understanding of the question of what net worth is and how to calculate it. The reality is that net worth can be either negative or positive. Net worth is positive if our assets exceed our total liabilities. Naturally, negative net worth should be the opposite of the previous definition. That is, when our liabilities exceed our total assets, net worth becomes negative. The positive and negative features of net worth act like a financial health monitor. When net worth is positive, it indicates a healthy and desirable financial situation, and when net worth is negative, it indicates a worrying crisis and an unhealthy financial situation.

Why is the Question of What Net Worth is and How to Calculate It Important?

Perhaps after reading our answers to the question of what net worth is and how to calculate it, you might ask, what is the benefit of all this? The benefit of net worth shows itself in large-scale financial actions. For instance, when a company wants to borrow from a lending institution, the first thing that the experts of the lending unit do is review the balance sheet. The balance sheet is like a financial encyclopedia where net worth is recorded in detail. Lenders, by examining the net worth, determine whether the borrowing company has a healthy financial performance or not. If you remember, we said that a healthy financial situation is when the total assets exceed the total liabilities; in other words, the net worth is positive.

Conclusion to the Question of What is Net Worth and How Do We Calculate It?

Now we come to the second part of the question: What is net worth and how do we calculate it? How should we calculate net worth? To calculate net worth, we need to have various real and up-to-date variables. To give a tangible example of the method for calculating net worth, let’s consider a couple who have listed their assets and liabilities. In this list, the assets are:

Residential house valued at $260,000
Investment portfolio worth $150,000 (An investment portfolio in economics refers to a range of financial assets such as bonds, stocks, real estate, alternative investments, and cash).
Car and other assets valued at $30,000

The list of liabilities includes:

Outstanding mortgage: $110,000
Car loan balance: $9,000

To calculate the net worth of this couple, we proceed as follows:

[260,000 + 150,000 + 30,000] − [ 110,000 + 9,000 ] = $321,000
[260,000+150,000+30,000]−[110,000+9,000]=$321,000

Life is never stable: Net Worth and the Variables of Life!

When we ask the question of what net worth is and how to calculate it, we must understand one reality well. That reality is that in real life, nothing remains stable. So it is natural that the wealth of this family changes over time and along with this change, their net worth also transforms. Let’s imagine the situation of this family six years later. After six years, the list of this family’s asset values has changed as follows:

Residential house valued at $240,000
Investment portfolio worth $170,000
Savings: $25,000
Car and other assets: $20,000

The list of liabilities:

Mortgage: $90,000
Car loan: $0

We calculate it in the same way as before:

[240,000 + 170,000 + 25,000 +20,000 ] − [ 90,000 +0 ] = $365,000

[240,000+170,000+25,000+20,000]−[90,000+0]=$365,000

The net worth of this family has increased. Despite the decrease in the value of the house and car, we see that this value has had an upward trend. The reason for this increase should be sought in the rise in the value of other assets, savings, and paying off the car loan.