Net worth, also known as book value for a business is a good snapshot that can help you understand the true wealth of an individual or business. Each person and every business has a net worth, and it is important to understand because it helps provide an overview of one’s finances, including non-cash holdings that aren’t typically thought of, such as a home, car, or equity in a business.
However, if assets are only being considered, it can be misleading because liabilities like debt frequently offset the total value of one’s assets. Net worth is a good metric because it shows asset values minus liabilities, creating a full, clear picture of a person or business’s financial health.
Knowing their current market value and net worth can help businesses as well as individuals determine what major purchases they can afford or where they should cut back to make smart financial decisions for the future.
One can also track their net worth and increase it by adding assets and reducing their liabilities, such as debts.
In this article, you’ll learn:
- What net worth is and why it is important
- How to calculate net worth
- The differences between assets and liabilities
- Ways to increase net worth
- Why net worth is important
What is net worth?
Put simply, net worth is the total value of what a person or a business owns minus what they owe. More specifically, it is the value of all of their owned assets minus the liabilities that they owe.
Net worth is also often called book value, and is an important metric that provides a useful snapshot of a business’s current financial position.
It can be used to determine if individuals qualify for certain investment strategies or financial products, such as hedge funds, structured products, and other more complex or alternative investments.
A big part of calculating net worth is knowing the difference between assets and liabilities and being able to list all of them correctly so one can get an accurate result.
Assets vs. liabilities
Assets and liabilities can be hard to properly define, and the particular categories contained in each can easily be forgotten as well.
Assets
An asset is anything a person or business owns that has monetary value.
Assets include all cash — whether they are in checking, savings, or retirement accounts — and certain investments, such as stocks and bonds that would equate to cash when sold. Stocks and bonds are also often referred to as liquid assets.
Fixed assets should also be included in a net worth calculation. These include real estate, equipment, vehicles, life insurance policies, jewelry, and much more.
Annual income is not considered among one’s assets when calculating their net worth.
Liabilities
Liabilities are obligations that deduct financial resources from one’s assets, such as loans, accounts payable (AP), and debts.
Any money that a person or business owes is a liability. This includes credit card debt and loans which can include but are not limited to: mortgages, personal, auto, student, payday, and title loans.
How to calculate net worth
The formula to calculate net worth is:
Assets – Liabilities = Net Worth
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Positive vs. negative net worth
Net worth also known as book value can be described as either positive or negative.
Having a negative net worth means that there are more liabilities than assets. In contrast, positive net worth means that assets outweigh liabilities.
A positive net worth can indicate good financial health, especially if it is continually increasing.
A decreasing net worth is concerning because it means there is more debt than total assets. This can happen for various reasons including excessive debt or asset value suddenly plunging. While a negative net worth is concerning it does not imply immediate consequences for a business or individual. It is common for young people to have negative net worth due to liabilities such as student loans, car loans, and mortgages.
Business vs. personal net worth
In business, net worth can also be called “book value” or “shareholders' equity”. For a business, their net worth is the same as their equity.
Lenders will look at a business's book value to determine if it is financially healthy enough to qualify for a loan. If a business has outstanding debt or a negative net worth, a creditor may not be confident in the company's ability to repay its loans and will likely not approve a loan for it.
For individuals, net worth is still important, because it can also be used to qualify for loans or to become an accredited investor. It is important for the individual to know their net worth so they can use it as an assessment of their personal financial health.
Example of net worth
Finding out one’s net worth is a simple calculation - the difficult part is putting together the list of assets and liabilities that go into it.
Here is an example of calculating an individual’s net worth:
Christopher Johnson is a successful entrepreneur and investor. Let's say Christopher's assets amount to $5 million, including his real estate holdings, investment portfolio, and savings accounts. His liabilities amount to $2 million, all of which includes a mortgage, several credit card balances, and other outstanding debts.
Johnson’s net worth would be calculated as follows:
Assets - Liabilities = Net Worth
$5 million - $2 million = $3 million
Through this simple calculating, one can determine that Christopher Johnson's net worth is $3 million.
Now, here is an example of a business’s net worth:
Veridian Ventures is a multinational company operating in various industries. Let's say Veridian Ventures’ total assets amount to $100 million, including cash reserves, real estate holdings, stocks, and intellectual property rights. Its total liabilities amount to $50 million, including outstanding debts and loans.
The business's book value would be calculated as follows:
Assets - Liabilities = Book Value
$100 million - $50 million = $50 million
Thus, Veridian Ventures’ net book value as a company is $50 million. This will also appear on the balance sheet as total equity.
How to increase net worth
The best way to increase net worth is by reducing liabilities while increasing assets. Working with a professional or virtual financial advisor can be extremely beneficial in helping individuals or businesses increase their net worth
Here are some strategies that can effectively impact a person or business’s net worth growth:
Budget
Developing a well-planned budget is a fundamental step towards increasing net worth. A strict budget will assist in prioritizing expenses, cut unnecessary costs, and allocate more funds toward debt reduction and savings.
Pay off debts
A company, or an individual, can undertake debt reduction strategies like the “debt snowball” or “debt avalanche”. The debt snowball method involves paying off the smallest debts first, while the debt avalanche method focuses on tackling debts with the highest interest rates, both effectively reducing debt liabilities over time. Negotiating with creditors may also be an option to alleviate the burden of debt.
Save
By diligently setting aside a portion of one’s income into a savings account, a person can accumulate a healthy amount of savings over time. This can provide a safety net and create opportunities for future investments.
Invest
Investing is another way to grow assets and exponentially increase net worth. Partnering with a financial institution or seeking advice from a professional can help you make informed investment decisions, providing a diverse and successful portfolio while aligning with your financial goals.
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Why is net worth important?
Net worth is an important financial metric because it provides a snapshot of an individual or a business's financial health and stability. Here are a few reasons why calculating net worth is so important:
Measure of financial progress
By calculating their net worth periodically, individuals and businesses can assess if their wealth is increasing or decreasing. It also serves as an effective benchmark when evaluating the effectiveness of financial strategies and investment decisions.
Financial planning
Net worth is also crucial for decisive financial planning. It helps individuals and businesses set realistic goals, make informed decisions about saving, investing, and budgeting, and determine major expenses such as buying real estate, equipment, starting a business, or retirement planning.
Risk assessment
Net worth helps individuals and businesses understand how well they can weather financial setbacks or unexpected events. For example, higher-than-average net worth can often provide a buffer against financial emergencies - such as equipment failure, emergency repairs, or other unexpected expenses - and reduces the likelihood of an individual or company falling into debt.
Investment analysis
Net worth helps investors determine how much of their total wealth is allocated to different asset classes. By comparing net worth to investment portfolios, individuals and businesses can evaluate diversification strategies, assess risk exposure, and adjust their investment allocations accordingly.
Financial positioning
A higher net worth indicates a stronger financial position, which can help negotiate better unsecured loan terms, business partnerships, or attract investment opportunities.
Wealth management
Net worth serves as a basis for wealth management decisions — determining asset allocation strategies, estate planning, tax management, and risk mitigation techniques to preserve and grow wealth over time.
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